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.The amount of debt forgiven must be reported on Form 982 and this form must be attached to your tax return

The Mortgage Debt Relief Act of 2007, however,  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 does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home's value or the taxpayer's financial condition.

The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home. This is known as qualified principal residence. If you refinanced, the debt is eligible but only up to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified. If you take out additional equity, that debt does not qualify for this exclusion.For instance, home equity lines of credit must have been used to make improvements to the home, and if used to buy a car would not qualify.

If the debt forgiven is not for your personal residence, the forgiven debt may qualify under the insolvency exclusion. Normally, you are not required to include forgiven debts in income to the extent that you are insolvent.  You are insolvent when your total liabilities exceed your total assets. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982. Publication 4681 discusses each of these exceptions and includes examples.

For more information about income taxes and real estate, see Income Tax Issues .

**NOTE: The information contained at this site is for educational purposes only , and although believed to be accurate, it is not intended for any particular person or circumstance. A competent tax professional should always be consulted to verify the information presented and before utilizing any of the information contained at this site.**