Special Tax Help for Cancelled Home Mortgage Debt
In the economic and housing crisis of recent years, some homeowners found themselves in situations where their homes value had fallen below what they owed on the mortgage, they couldn't afford to make home mortgage payments, or both.
As a result, many were forced to default on their loans, have them go into foreclosure, or if they were fortunate enough, enter into a loan modification agreement with the lender.
If a lender, such as a bank or mortgage company, cancels or forgives money you owe them, you normally would have to pay tax on that amount, since debt forgiveness is considered income under the tax law.
But when it comes to your home, an important exception to this rule could apply in 2013.
Here are several key pieces of information about the special exclusion for cancelled home mortgage debt:
- If the cancelled debt was a mortgage loan on your main home, you may be able to exclude the cancelled amount from your income. To qualify you must have used the loan to buy, build or substantially improve your main home. The loan must also be secured by your main home.
- If your lender cancelled part of your mortgage through a loan modification, or `workout,' you may be able to exclude that amount from your income. You may also be able to exclude debt discharged as part of the Home Affordable Modification Program (HAMP). The exclusion may also apply to the amount of debt cancelled in a foreclosure.
- The exclusion could be applicable to amounts cancelled on a refinanced mortgage. This applies only if you used proceeds from the refinancing to buy, build or greatly improve your main home. Proceeds used for other purposes don't qualify. For example, a loan that you used to pay your credit card debt doesn't qualify.
- Other types of cancelled debt do not qualify for this special exclusion. This includes debt cancelled on second homes, rental and business property, credit card debt or car loans. Cancellation of these types of debt generally is considered taxable income.
- If your lender reduced or cancelled at least $600 of your mortgage debt, you should receive Form 1099-C, Cancellation of Debt, from the lender. This form shows the amount of cancelled debt and other information. You should notify your lender if any information on the form is wrong.
- Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, is the form to report the excluded debt on your return. File the completed form with your federal (and possibly state) tax return.
- The IRS provides a tool you can use called the “Interactive Tax Assistant” on IRS.gov to find out if you must pay tax on cancelled mortgage debt.
For more on this topic, the IRS has Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments, available for you. Like the Interactive Tax Assistant mentioned above, this publication and other assistance is available at IRS.gov.
