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Some frequently asked questions about the Mortgage Debt Forgiveness Act:

General Rule

Federal law generally requires that any debt that is forgiven or cancelled by a lender must be included as income on the borrower’s tax return and is taxable. The amount of the forgiven debt is identified on a 1099.  Federal law requires that a 1099 must be issued by a lender anytime there is debt that is forgiven and expressly prohibits the lender from agreeing to not issue a 1099 when one is otherwise required.

Here are three instances where a 1099 is triggered based on Date of Debt relief which includes:

  • Trustee sale / Foreclosure Date
  • Short sale closing
  • Debt settlement date

Do I have taxable income?

Despite the general rule, not all debt relief is treated as taxable income. There are several exceptions to the general rule.

  1. Qualified Principal Residence.  An exception to the general rule is found in the Mortgage Debt Relief Act of 2007.  It provides that a 1099 received from forgiven or cancelled debt used to buy, build or substantially improve the borrower’s principal residence, or to refinance debt incurred for these purposes, may be excluded as income.  This law expires on January 1, 2014.  The general rule will once again apply to the circumstances identified in this law.
  2. Discharge of debt in a bankruptcy proceeding.
  3. Insolvency.  Includes retirement accounts in asset determination.
  4. Non-recourse debt.  Law is ambiguous on whether the anti-deficiency law makes a loan non-recourse.

Strategies for dealing with taxable income?

If there is taxable income, then there are several strategies for addressing the consequences.  These include, but are not limited to, the following:

  1. Income producing property.  Allows an ordinary loss in the year of the debt relief.
  2. Investment/inventory property.  Taxpayer limited to a capital loss.  Meaning, the taxpayer’s loss has an annual limit of $3,000, or $1,500 if married filing separately, plus a dollar for dollar offset against all capital gains.  Put another way, if the capital loss exceeds the capital gains, the excess can be deducted on the taxpayers tax return and used to reduce other income, such as wages, up to an annual limit of only $3,000, or $1,500 if married filing separately.  If the total net capital loss is more than the yearly limit on capital loss deductions, the taxpayer can carry over the unused part to the next year and the years thereafter until exhausted.

Capital Gains

Primary Residence Exclusion.  Allows exclusion of up to $250,000, or $500,000 if married, from taxes if the taxpayer meets the Primary Residence Exclusion requirements.

  1. Owned the residence for any two of the last five years.
  2. Occupied your residence for any two of the last five years.
  3. Haven’t used the exclusion within the last two years.

You can visit the IRS for more information on this subject or contact us directly at  602.635.9108

Copyright 2010 – William A. Kozub, Esq.,     Berens, Kozub & Kloberdanz, PLC, (480) 624-2777
This material does not constitute legal advice and does not create an attorney client relationship.  Any decisions concerning Arizona’s anti-deficiency law, your liability under any financial obligation, and the tax consequences arising there from should only be made after consultation with a qualified attorney or tax law professional.