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How to Know if Your Canceled Mortgage Debt is Tax Exempt

March 14th, 2011 · 4 Comments · Taxes

Meredith Simonds

by Meredith Simonds

Do you qualify for a special exemption on canceled  mortgage debt this tax season? Whether it was through a loan modification, short sale or foreclosure, the mortgage debt you have been forgiven does not count as taxable income provided it meets two main qualifications.

As reported by the Boston Herald, under the Mortgage Forgiveness Debt Relief Act of 2007 you are exempt from paying taxes on canceled mortgage debt if:

1) The residence in question is your primary home and not a second home or rental

2) The debt forgiven was used to buy, build or improve the residence and not used for an unrelated expense such as college tuition, vacations, new cars or credit card debt

Other details of note, as outlined on the official IRS website, are as follows:

  • The maximum amount you can treat as qualified principal residence indebtedness is $2 million ($1 million if married filing separately for the tax year), at the time the loan was forgiven.
  • If you have canceled debt but have not received a 1099-C Cancellation of Debt form, request one. The amount of debt forgiven or canceled will be shown in box 2. If this debt is all qualified principal residence indebtedness, the amount shown in box 2 will generally be the amount that you enter on lines 2 and 10b, if applicable, on Form 982.
  • Though not covered under Mortgage Forgiveness Debt Relief Act of 2007, canceled debt on student loans and credit cards may be exempt under different provisions.

For more information refer to Publication 4681 and Form 982, and the official IRS website.

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4 Comments so far ↓

  • Jeff

    I have a property that was my family’s primary residence from Apr 2000 – Jul 2007. Due to job relocation, we had the property on the market for about 2.5 yrs. At that point (approx. Aug 2009), we allowed some friends to rent it for amount well below our mortgage payment and they couldn’t keep up payments. So, they only rented for about 7 months (the minimal amount of rental income did allow us to purchase a home at our new location). We relisted the property in about May 2010 for short sale. We received a short sale offer in December 2010 and the bank just approved the offer and wants to close by Apr 14, 2011. The deficiency on the note is approx $60K and the bank will not be seeking deficiency judgement, but will be filing 1099c. I’m concerned with potential tax liability. We lost so much on this proerty over the past 4 yrs that it seems unthinkable that we’d be required to pay 28% tax on the $60K deficiency. At any rate, we have heard that there are some stipulations relative to the Mortgage Forgiveness Debt Relief Act that may aply to us (employer relocation issues, was primary residence before job relocation, etc). Are you able to shed some light on whether I can qualify for this exemption?

  • Meredith Simonds

    Thanks for the question, Jeff. With so many variables involved my best advice is to ask the same of a certified tax preparer or, better yet, a tax attorney. Love to know what you find out.

  • Dave

    Hi Meredith,

    Quick question for you. I have a HELOC 2nd which was used for home improvement. It’s my principle residence. The property probably has some equity but my HELOC bank gave us a settlement anyway. That was a few months ago and now we are selling the property. So my question is from the way you understand it, since the forgiven principle was used to upgrade the house and it’s my primary residence, then we should probably be exempt from taxes, correct? If so, do you know if there’s a cap? They forgave $200K.

  • Meredith Simonds

    Hi, Dave. Thank you so much for the question. I only wish I had an answer. I suggest you consult a tax attorney.

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