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IRS Tax Tip 2013-31: Important Facts about Mortgage Debt Forgiveness
If your lender cancelled or forgave your mortgage debt, you generally have to pay tax on that amount. But there are exceptions to this rule for some homeowners who had mortgage debt forgiven in 2012.
Here are 10 key facts from the IRS about mortgage debt forgiveness:
1. Cancelled debt normally results in taxable income. However, you may be able to exclude the cancelled debt from your income if the debt was a mortgage on your main home.
2. To qualify, you must have used the debt to buy, build or substantially improve your principal residence. The residence must also secure the mortgage.
3. The maximum qualified debt that you can exclude under this exception is $2 million. The limit is $1 million for a married person who files a separate tax return.
4. You may be able to exclude from income the amount of mortgage debt reduced through mortgage restructuring. You may also be able to exclude mortgage debt cancelled in a foreclosure.
5. You may also qualify for the exclusion on a refinanced mortgage. This applies only if you used proceeds from the refinancing to buy, build or substantially improve your main home. The exclusion is limited to the amount of the old mortgage principal just before the refinancing.
6. Proceeds of refinanced mortgage debt used for other purposes do not qualify for the exclusion. For example, debt used to pay off credit card debt does not qualify.
7. If you qualify, report the excluded debt on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. Submit the completed form with your federal income tax return.
8. Other types of cancelled debt do not qualify for this special exclusion. This includes debt cancelled on second homes, rental and business property, credit cards or car loans. In some cases, other tax relief provisions may apply, such as debts discharged in certain bankruptcy proceedings. Form 982 provides more details about these provisions.
9. If your lender reduced or cancelled at least $600 of your mortgage debt, they normally send you a statement in January of the next year. Form 1099-C, Cancellation of Debt, shows the amount of cancelled debt and the fair market value of any foreclosed property.
10. Check your Form 1099-C for the cancelled debt amount shown in Box 2, and the value of your home shown in Box 7. Notify the lender immediately of any incorrect information so they can correct the form.
Use the Interactive Tax Assistant tool on IRS.gov to check if your cancelled debt is taxable. Also, see Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments. IRS forms and publications are available online at IRS.gov or by calling 800-TAX-FORM (800-829-3676).
Additional IRS Resources:
Interactive Tax Assistant tool
Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments
Mortgage Forgiveness Debt Relief Act and Debt Cancellation
Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness
IRS YouTube Videos:
Mortgage Debt Forgiveness – English | Spanish | ASL
IRS Announces Guidance on the Principal Reduction Alternative Offered in the Home Affordable Modification Program (HAMP)
IR-2013-8, Jan. 24, 2013
WASHINGTON — The Internal Revenue Service today announced guidance to borrowers, mortgage loan holders and loan servicers who are participating in the Principal Reduction AlternativeSM offered through the Department of the Treasury’s and Department of Housing and Urban Development’s Home Affordable Modification Program® (HAMP-PRA®).
To help financially distressed homeowners lower their monthly mortgage payments, Treasury and HUD established HAMP, which is described at http://www.makinghomeaffordable.gov. Under HAMP-PRA, the principal of the borrower’s mortgage may be reduced by a predetermined amount called the PRA Forbearance Amount if the borrower satisfies certain conditions during a trial period. The principal reduction occurs over three years.
More specifically, if the loan is in good standing on the first, second and third annual anniversaries of the effective date of the trial period, the loan servicer reduces the unpaid principal balance of the loan by one-third of the initial PRA Forbearance Amount on each anniversary date. This means that if the borrower continues to make timely payments on the loan for three years, the entire PRA Forbearance Amount is forgiven. To encourage mortgage loan holders to participate in HAMP–PRA, the HAMP program administrator will make an incentive payment to the loan holder (called a PRA investor incentive payment) for each of the three years in which the loan principal balance is reduced.
Guidance on Tax Consequences to Borrowers
The guidance issued today provides that PRA investor incentive payments made by the HAMP program administrator to mortgage loan holders are treated as payments on the mortgage loans by the United States government on behalf of the borrowers. These payments are generally not taxable to the borrowers under the general welfare doctrine.
If the principal amount of a mortgage loan is reduced by an amount that exceeds the total amount of the PRA investor incentive payments made to the mortgage loan holder, the borrower may be required to include the excess amount in gross income as income from the discharge of indebtedness. However, many borrowers will qualify for an exclusion from gross income.
For example, a borrower may be eligible to exclude the discharge of indebtedness income from gross income if (1) the discharge of indebtedness occurs (in other words, the loan is modified) before Jan. 1, 2014, and the mortgage loan is qualified principal residence indebtedness, or (2) the discharge of indebtedness occurs when the borrower is insolvent. For additional exclusions that may apply, see Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals).
Borrowers receiving aid under the HAMP–PRA program may report any discharge of indebtedness income — whether included in, or excluded from, gross income — either in the year of the permanent modification of the mortgage loan or ratably over the three years in which the mortgage loan principal is reduced on the servicer’s books. Borrowers who exclude the discharge of indebtedness income must report both the amount of the income and any resulting reduction in basis or tax attributes on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).
Guidance on Tax Consequences to Mortgage Loan Holders
The guidance issued today explains that mortgage loan holders are required to file a Form 1099-C with respect to a borrower who realizes discharge of indebtedness income of $600 or more for the year in which the permanent modification of the mortgage loan occurs. This rule applies regardless of when the borrower chooses to report the income (that is, in the year of the permanent modification or one-third each year as the mortgage loan principal is reduced) and regardless of whether the borrower excludes some or all of the amount from gross income.
Penalty relief is provided for mortgage loan holders that fail to timely file and furnish required Forms 1099-C, as long as certain requirements described in the guidance are satisfied.
Details are in Revenue Procedure 2013-16 available on IRS.gov.
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