The Mortgage Forgiveness Debt Relief Act of 2007 allowed for exclusion of income realized from debt reduction that occurred from a taxpayer’s principal residence. This was set to expire on December 31, 2012. The fiscal cliff bill enacted in January 2013 extended some of the mortgage debt relief provisions for homeowners.
Every taxpayer has a different situation, and the facts and circumstances will determine if their cancellation of debt is a taxable or non-taxable event.
Learn the various types of debt and how they are treated for tax purposes:
• Principal residence indebtedness
• Mortgage loan modifications
• Recourse debt
• Nonrecourse debt
• Qualified real property business indebtedness
• Student loans
• Vehicle repossessions
What happens when a taxpayer has a foreclosure or abandonment, and what are the tax implications if they are insolvent or file for bankruptcy?
Qualified Principal Residence Indebtedness
You can exclude canceled debt from income if it is qualified principal residence indebtedness. Qualified principal residence indebtedness is any mortgage you took out to buy, build, or
substantially improve your main home. It also must be secured by your main home. Qualified principal residence indebtedness also includes any debt secured by your main home that you used to refinance a mortgage you took out to buy, build, or substantially improve your main home, but only up to the amount of the old mortgage principal just before the refinancing.
Main home. Your main home is the home where you ordinarily live most of the time. You can have only one main home at any one time.
Note. This exclusion does not apply to a cancellation of debt in a title 11 bankruptcy case. If qualified principal residence indebtedness is canceled in a title 11 bankruptcy case, you must apply the bankruptcy exclusion rather than the exclusion for qualified principal residence indebtedness. If you were insolvent immediately before the cancellation, you can elect to apply the insolvency exclusion (as explained under Insolvency, earlier) instead of applying the qualified principal residence indebtedness exclusion. To do this, check the box on line 1b of Form 982 instead of the box on line 1e.
Exclusion limit. The maximum amount you can treat as qualified principal residence indebtedness is $2 million ($1 million if married filing separately). You cannot exclude canceled
qualified principal residence indebtedness from income if the cancellation was for services performed for the lender or on account of any other factor not directly related to a decline in the value of your home or to your financial condition.
Ordering rule. If only a part of a loan is qualified principal residence indebtedness, the exclusion applies only to the extent the amount canceled is more than the amount of the loan
(immediately before the cancellation) that is not qualified principal residence indebtedness. The remaining part of the loan may qualify for another exclusion.
How to report the qualified principal residence indebtedness exclusion. To show that all or part of your canceled debt is excluded from income because it is qualified principal residence
indebtedness, attach Form 982 to your federal income tax return and check the box on line 1e.
On line 2 of Form 982, include the amount of canceled qualified principal residence indebtedness, but not more than the amount of the exclusion limit (explained earlier). If you continue to own your home after a cancellation of qualified principal residence indebtedness, you must reduce your basis in the home as explained under Reduction of Tax Attributes
Get more great content when you view Andrew's on-demand NSA ConnectED Webinar:
Financially Distressed Taxpayers: Cancellation of Debt, Foreclosures and Repossessions
Author
Andrew G. Poulos, EA, is principal of Poulos Accounting & Consulting, Inc., in Atlanta, Ga., where he focuses working with tax clients and representing clients before the IRS. Andrew is the producer of the QuickBooks Ultimate Lesson Guide DVD Series being marketed nationally through wholesale and retail distribution channels. He is also founder of Elite Tax Seminars, a division of Poulos Accounting & Consulting, Inc.
#Tax #taxpolicy #NewsandInformation #Consumer #taxplanning #PersonalIncomeTax