IT’S PROBABLY the cliché of our economic times: foreclosures and short sales one after the other have triggered too many sleepless nights among honest Americans who were trapped into mortgages which were designed to be too perplexing for the average Joe to fathom.
IRS Publication 525 explains, “Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income.”
Unless an exception applies, anytime a lender cancels your debt, the event would be considered a taxable income to you, the taxpayer or debtor. The lender will send you Form 1099-C at the end of the tax year and you should report that in your income tax return as you file your taxes.
However, the tax code has provided some exceptions for you to be able to claim this as an exemption.
If you have lost your home through foreclosure or mortgage refinancing or restructuring, you might not have to pay income tax on the amount of cancelled debt, which is reported in 1099-C. The amount you could exclude on a cancelled mortgage debt will be up to $2 million for married couple filing jointly and $1 million for a married person filing separately.
For you to qualify, the house would have been used as a main home, meaning it was the main place of residence of the homeowner. On a refinancing program, the house must have been used to buy, build, or make substantial improvements to the residence.
But there are restrictions on this exemption. A home equity loan which was not used to buy, build, or make substantial improvements to the house won’t qualify for forgiveness. So if the money borrowed was used to pay off credit card debts and grand European vacations, you will have to end up giving Uncle Sam its share of the pie.
Furthermore, the IRS clarifies the tax exemption this way: “Taxpayers can exclude up to $2 million of debt forgiven on their principal residence. The limit is $1 million for a married person filing a separate return. This provision applies to debt forgiven in 2007, 2008 or 2009. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure qualify for this relief.”
Aside from the provision that the house was used as a main residence, the IRS also allows other exemption criteria. Canceled debt can be forgiven if the debt was canceled in a bankruptcy case, if the individual is insolvent, or if it was intended as a gift. Certain businesses may also qualify under this provision.
Insolvency may provide a sparkle of hope for those who did not use the foreclosed or short-saled home as a main residence nor was the canceled debt discharged in a bankruptcy proceeding.
An individual is insolvent if the value of their assets is less than the value of their liabilities. The best approach will be to calculate the value of your assets immediately before the cancellation against your liabilities. If the result is negative, your debt can be forgiven. You can relax and secure that much-needed sleep.
As you go through these life challenging events, you may contact my office if you need any assistance.
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Evangeline can be reached at her marketing location at the Ground Floor of Eagle Rock Plaza (in front of Jollibee), 2700 Colorado Blvd., Los Angeles, CA 90041 or at her business address at 450 N. Brand Blvd., Ste. 600, Glendale, CA 91203, phone number (323) 356-3803 or (323) 254-6787.
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The purpose of this article is to provide information of general interest to our clients and prospective clients. The information provided is general in nature and should not be considered complete information on any product or concept described.
