photo by flickr (cc-by)
New rules allow qualifying mortgage debts to be erased tax-free. Congress hopes to give a soft landing to taxpayers victimized by the housing crisis.
If you’re seeking a short sale, loan modification, or debt forgiveness, be sure to download a copy of your past tax returns.
Before the new rule went into effect, a homeowner whose debt was forgiven was required to pay taxes on that amount. This makes sense because essentially the lender is handing you money to walk away from the property.
But because of the breadth of the mortgage crisis of the last year, Congress decided to change the rules. So if the money owed was used to buy or improve your principal home, then the debt forgiven is tax free. This new rule applies through 2012 and up to $2 million in debt. You may also used the exclusion on multiple houses up to that limit. In other words, nothing stops you from making your second home your principal residence and seeking forgiveness on it.
When you go to file your tax return after the debt is forgiven you are required to report the amounts in question including the debt and the actual value of the home. See tax form 982 or publication 4681 for instruction on reporting these figures.
If you don’t qualify for this benefit, you must report canceled debts as ordinary income and pay taxes on it.
What is the process for getting a debt forgiven by a creditor?