What Is The Mortgage Forgiveness Debt Relief Act?

Our lawyer Cynthia Lewis was recently interviewed by WFTV Channel 9 news regarding the changes in the Mortgage Debt Relief Act, which expired on December 31, 2013. To watch her interview, click here.

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Mortgage Forgiveness Debt Relief Act Expires, May Result in Tax Debt in the Case of Foreclosure or Short Sales!
By: Attorney Cynthia Lewis

The Mortgage Forgiveness Debt Relief Act extends the bankruptcy and insolvency exceptions to taxable income for cancellation of debt to debts canceled due to mortgage modification, mortgage forgiveness, foreclosure or short sale of a person's principal residence without filing a bankruptcy or qualifying as being insolvent.

As of January 1, 2014, homeowners will no longer have the ability to claim debt forgiven on their principal residence as non-taxable income. The Mortgage Forgiveness Debt Relief Act that was extended twice expired on December 31, 2013.

Typically cancellation of debt, of any kind, will result in the same amount being considered income to the person whose debt was canceled. Cancellation of debt is typically from a credit card or other loan forgiveness. In the case of mortgages, it can come from foreclosure, short sale, second mortgages or equity lines being written-off or principal forgiven through mortgage modification. When a debt is canceled or forgiven, the person whose debt has been canceled receives a 1099-C showing the debt forgiven as income. This phantom income must be reported to the IRS on that year's tax return and likely results in increased taxes being due. The most common ways that this phantom income would not be taxable is if it was forgiven as a result of a bankruptcy filing or if the person filing was insolvent at the time of the debt forgiveness.

Since 2007, homeowners, whose mortgage debt on their principal residence was forgiven, have been able to show phantom income as non-taxable on their IRS tax returns. That debt had to meet the necessary qualifications of having been incurred for the purchase, substantial improvement to the principal residence or refinancing of the principal residence. This non-taxable status could be applied to debt forgiven due to a deficiency in mortgage loan pay-off from a foreclosure or short sale, as well as principal reduction from a mortgage modification or simply the forgiveness of a second mortgage or equity line. Beginning January 1, 2013, that option for non-taxability of debt forgiveness will no longer be available to homeowners. When we are talking about $100,000 of mortgage debt being forgiven, the tax obligation can become quite sizable.

However, homeowners will still be able to claim mortgage debt cancellation as non-taxable if it is accomplished through any Chapter (7, 13 or 11) of bankruptcy. Cancellation of debt is also not taxable if the homeowner can show they were insolvent at the time of the debt forgiveness. The analysis for either a bankruptcy solution or an insolvency solution can become quite complicated so any homeowner facing a foreclosure, short sale or mortgage modification cancellation of debt should speak with a professional when considering their options.