Mortgage Forgiveness Debt Relief Act Part 2

If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is normally reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.

Example. Assume that a residential home was purchased in 2005 for $200,000. The value of the home has declined to $180,000 and payments are in arrears. The delinquency has added interest and late fees to the mortgage balance, which is now $198,000. The mortgagee (bank) forecloses on the home and later resells it for $170,000. The result is a nondeductible loss of $30,000 and Cancellation of Debt (COD) income of $28,000.

Gain/Loss on Sale:

$170,000 Selling Price

– $200,000 Original Cost

$ 30,000 Nondeductable Loss

COD Income:

$198,000 Mortgagge and past due interest

-$170,000 Selling Price

$ 28,000 COD Deductable Loss

It is clear that the negative tax consequence is the result of two items: the low selling price received by the mortgage company, and the high debt resulting from accrued interest and penalties.

Mortgage Forgiveness Debt Relief Act

The banks are really feeling the heat as a result of the real estate market crisis and the rise of home mortgage foreclosures. During the recent U.S. real estate boom, some lending institutions abandoned all caution. Lending policies became extremely lax. Dubious loans—such as the so-called “Ninja” (no income, no job or assets) loans—became increasingly commonplace. Many banks made these bad loans because it was assumed that the price of the home would always appreciate. What a surprise these lenders got when the real estate market bottom fell out.

In December 2007, President Bush signed the Mortgage Forgiveness Debt Relief Act of 2007. It will rescue many families facing foreclosure on their personal residences. The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. This provision applies to debt forgiven in calendar years 2007 through 2012.

• Up to $2 million of forgiven debt is eligible for this exclusion.


• $1 million if married filing separately.


• The exclusion can be used only if the loan was taken out to acquire, build or substantially improve a principal residence. Forgiveness of debt on vacation homes, second homes and investment property doesn't qualify.

More information, including detailed examples can be found in Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. Also see IRS news release IR-2008-17.