THE exclusion from gross income of discharged qualified principal residence indebtedness is extended for two years through December 31, 2016. It applies to discharge occurring before January 1, 2017 or subject to an arrangement entered into and evidenced in writing before January 1, 2017 code section 108(a)(1)(E) amended by the Protecting Americans from Tax Hikes (PATH) Act of 2015. The exclusion however does not apply to the amount of gain recognized from foreclosure, short sale, or deed in lieu of foreclosure.
1. As a general rule, cancellation-of debt (COD) results in taxable income code section 61(a) (12). The COD income is generally equal to the difference between the amount of indebtedness cancelled and the amount used to satisfy the debt. There is no COD income if you are not personally liable for a debt or non-recourse loan, where the lender’s only recourse is the property secured by the debt.
2. Under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude debt forgiven on your principal residence.
3. Refinanced debt proceeds used to improve your principal residence.
4. The debt must have been used to buy, build, or substantially improve your principal residence.
5. Refinance debt proceeds used for other purposes (travel, buy a car, or pay off credit card debt) does not qualify for the exclusion.
6. The debt must be secured by your main residence.
7. For this tax relief provision, debt forgiven on second homes, rental property and business property do not qualify (but may qualify for other tax relief).
8. The exclusion is limited up to $2 million ($1 million for married filing separate taxpayers). This exclusion was set to expire in 2013 but was extended to December 31, 2014. This was again extended to December 31, 2016 with the signing of the PATH Act by President Obama.
9. If you meet the requirements, complete Form 982 and reduce tax attributes as required for the exclusion method. It is important to check the appropriate box indicating the type of exclusion. This form is attached to your federal income tax return for the tax year in which the qualified debt was discharged.
When basis is required to be reduced (but not below zero) under code section 1017, a list of the property and the amount of basis reduction for each property much be attached to your federal tax return as a supplemental worksheet to your Form 982.
10. If your debt is eliminated or reduced, you would normally receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. The form shows the fair market value of any property foreclosed and the amount of debt forgiven. Carefully examine Form 1099-C. If any of the information shown is incorrect, please notify the lender immediately. You should pay extra attention to the amount of debt discharged in Box 2, amount of interest included in Box 2 and is reported in Box 3, as well as the fair market value listed for your home in Box 7.
In accordance with IRS Circular 230, this communication is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purpose.
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