Homeowners who've had mortgage debt forgiven (canceled)—perhaps after a foreclosure, short sale, or deed in lieu of foreclosure—sometimes owe federal income tax on that forgiven debt come tax time. To learn about the tax implications of forgiven debt and whether you can exclude it from your taxable income on your federal tax return, read on.
Ordinarily, when $600 or more of debt is forgiven or canceled by a creditor, the amount that has been forgiven is considered income for federal tax purposes, whether the debt is a mortgage or another kind of credit. The amount of the loan is considered income only once it's forgiven—and not when you first borrowed the money. When it's clear you won't be repaying the money you received, tax law recognizes the money as income. That means you must report the forgiven amount on your tax return and pay taxes on it, just like any other kind of income, unless you qualify for an exception or exclusion.
To keep financially strapped homeowners from taking a second hit at tax time, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007. Under this law, if part or all of your mortgage debt on your principal residence is forgiven, you might be able to exclude as much as $2 million of that forgiven debt from your taxable income.
The Mortgage Forgiveness Debt Relief Act of 2007 was originally scheduled to sunset in 2010, but was extended through 2012 by the Emergency Economic Stabilization Act of 2008. It was extended again (through 2013) by the fiscal cliff legislation in early 2013. And then the law was extended again on December 19, 2014, as part of the Tax Increase Prevention Act, to include debt forgiven through 2014. The law was later extended for a fourth time to apply to debt forgiven in calendar years through 2016, as well as debt discharged in 2017 if there was a written agreement entered into in 2016.
On February 9, 2018, President Trump signed the Bipartisan Budget Act of 2018. One provision of the law extended the Mortgage Forgiveness Debt Relief Act to include indebtedness that is discharged before January 1, 2018, and to written discharge agreements executed before January 1, 2018.
So, this exclusion applies to debt forgiven in calendar years through 2017, as well as debt discharged in 2018 if there was a written agreement entered into in 2017.
If some or all of your mortgage debt has been forgiven by your lender, will you be able to get out of paying income tax on that forgiven debt under the Mortgage Forgiveness Debt Relief Act of 2007?
Here are the key factors to remember.
The IRS has more information about the Mortgage Forgiveness Debt Relief Act of 2007 and instructions for taxpayers at www.irs.gov.
If you don't qualify for tax relief under the Mortgage Forgiveness Debt Relief Act of 2007, you might qualify for another kind of exception or exclusion. For instance, cancellation of debt income generally isn't taxable if the debt has been discharged in bankruptcy (before it's forgiven), you're insolvent when the debt is forgiven, the debt is a certain kind of farm debt, or if the property was subject to a nonrecourse debt. (A "recourse debt" is a loan that the borrower is personally liable to repay.)
Tax laws are complicated. If you have questions about whether you have to report canceled debt as income on your taxes or whether you qualify for an exception or exclusion, talk to a tax lawyer.