Eight Facts You Should Know about the Special Exclusion for Canceled Home Mortgage Debt

Larry Villano, Publisher of Loopholelewy.com

Usually, if a lender lets you off the hook for a loan, you have to include the canceled amount in your income where it becomes part of your taxable income. Canceled debt is also referred to as debt forgiveness. For example, if you cut a deal with your credit card company to reduce your debt from $10,00 to $6,000, $4,000 must be included your income.

This was also true for home mortgage debt prior to the passage of the Mortgage Debt Relief Act of 2007 which 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, also qualifies for the relief.

This exclusion applies to home mortgage debt forgiven in calendar years 2007 through 2013. 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.

Here are eight facts from the IRS about the special exclusion for canceled home mortgage debt:

1. If the canceled debt was a mortgage loan on your main home, you may be able to exclude the canceled amount from your income.

2. 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.

3. If part of your mortgage was canceled 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. Visit Irs.gov. for more details about HAMP.

4. The exclusion may also apply to the amount of debt canceled in a foreclosure.

5. The exclusion may apply to amounts canceled 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.

6. Other types of canceled debt do not qualify for this special exclusion. This includes debt canceled on second homes, rental and business property, credit card debt or car loans.

7. If your lender reduced or canceled at least $600 of your mortgage debt during 2013, you should receive Form 1099-C, Cancellation of Debt, in January 2014. This form shows the amount of canceled debt and other information. Make sure you let your lender know if any information on the form is wrong.

8. Report the excluded debt on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. File the completed form with your federal tax return.