Mortgage Forgiveness Debt Relief Act of 2007
The Mortgage Forgiveness Debt Relief Act was introduced in the United States Congress on September 25, 2007, and signed into law by President George W. Bush on December 20, 2007. This act offers relief to homeowners who would have owed taxes on forgiven mortgage debt after facing foreclosure. The act extends such relief for three years, applying to debts discharged in calendar year 2007 through 2009. With the Emergency Economic Stabilization Act of 2008, this tax relief was extended another three years, covering debts discharged through calendar year 2012. Act further extended until January 1, 2014 at section 202 of American Taxpayer Relief Act of 2012.
In the eyes of the Internal Revenue Service (IRS), housing debt that is forgiven or written off is the same as income. If the law expires, forgiven mortgage debt will be taxable. The same applies to foreclosures and to loan modifications in which principal is reduced.
Once the lender writes off the debt, it will report the amount to the IRS. Homeowners should expect to receive Form 1099-C showing the canceled debt amount.
All taxpayers, including those who qualify for the exemption, will get the form in the mail if they had debt canceled. Those who qualify for the exclusion will be required to file Form 982 when they file their taxes. The exemption applies only to debt related to a primary home. Mortgages on vacation and rental properties are not exempt under the act. Homeowners who did cash-out refinances and used the money for any other purpose than fixing up their house could still be on the hook for forgiven debt.
However, after the signing of the Mortgage Forgiveness Act, amendments have been made to remove such tax liability and allow the borrower and lender to work freely together to find a common solution that is beneficial to both parties. This protection is limited to primary residences—rental properties are ineligible for relief—so consultation with a tax advisor is necessary to ensure that a borrower qualifies. The amount of forgiven mortgage debt allowed to be excluded from income tax is limited to $2 million per year.
Meaning of “Cancellation of Debt”
If you’ve borrowed money and your lender cancels/terminates or forgives the outstanding loan balance owed to you at a later stage, then you, as per the Internal Revenue Service will be liable to file an income tax return on the forgiven debt amount with respect to the corresponding situations. At the time of loan origination, the loan money that you received weren’t considered as an income because you made an agreement to pay back the borrowed sum to the lender, i.e., it was your obligation to repay the loan amount as per the signed contract’s terms and conditions. However, when your obligation to pay back the borrowed sum has been ‘cancelled’ or forgiven, then the payable debt amount becomes reportable as income. The simple reason for it is that you are longer obligated to repay the loan to the lender. Meanwhile, it is the lender who has to report the cancelled debt to the IRS as well as to you using Form 1099-C, better known as “Cancellation of Debt”.