DEBT FORGIVENESS GUIDELINES
Thousands of Boise homeowners have experienced a short sale of their primary home over the past several years, but many may not know about the tax consequences of a short sale. Tax consequences are one of the first questions that I am asked as a Boise Certified Distressed Property Expert when counseling clients about their foreclosure options. All homeowners should consider the following information from the IRS about short sale debt forgiveness when considering whether a short sales is the best option for them to avoid foreclosure.
When a lender writes off any part of a mortgage balance (debt forgiveness), the portion of the balance that was forgiven becomes taxable income to the borrower under IRS guidelines.
In 2007, congress passed the Mortgage Forgiveness Debt Relief Act (MFDRA) in response to the burgeoning mortgage default crisis. Under the MFDRA, borrowers may be allowed to exclude up to $2 million of mortgage debt on a principal residence from 2007 through 2012; however there is a $1 million dollar limit for a married person when filing a separate tax return. The MFDRA also includes debt reduced through a mortgage restructuring program.
The MFDRA also includes mortgages for home improvement projects as long as the improvements “substantially improve” the borrowers principle residence. Homeowners should contact a qualified CPA for details regarding what constitutes as a “substantial improvement”. Any secondary mortgage(s) taken out for other purposes not related to home improvement would not qualify for debt forgiveness with the possible exception of certain bankruptcy considerations.
During the short sale process, homeowners will need to pay special attention to the short sale approval letter issued by their lender(s). The approval letter will often outline issues regarding debt forgiveness and may reference IRS Form 1099-C which is an indication a portion of the mortgage debt may be forgiven. A lender will send Form 1099-C after a short sale is approved and they must include certain information on the form such as the amount of debt forgiven and the fair market value of property if foreclosed. Be sure to review the 1099-C upon receipt of it for accuracy.
All Boise homeowners who have successfully sold their home by short sale must complete Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness when filing their federal income tax return for the year mortgage debt was forgiven.
All Boise homeowners that have gone through a short sale or are considering a short sale to avoid foreclosure should contact a qualified CPA for expert financial counseling. In addition, the IRS provides online tools to assist as well. The Interactive Tax Assistant is a user friendly tool that can be found at irs.gov as well as Publication 4681: Canceled Debts, Foreclosures, Repossessions and Abandonments.