One of the key provisions of the “Fiscal Cliff” compromise recently signed into law was the one year extension of the Mortgage Forgiveness Debt Relief Act. Congress originally passed this legislation in 2007 which generally allows taxpayers to exclude the forgiveness of mortgage debt from being counted as taxable income by the Internal Revenue Service. Debt on a homeowner’s primary residence that is reduced through a short-sale, foreclosure, or other forms of mortgage restructuring now continue to qualify for this type of relief, at least for another year.
Normally when you borrow money from a commercial lender and the debt is cancelled or forgiven, absent certain exceptions, you may have to include the cancelled amount as income for tax purposes. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt. The Mortgage Forgiveness Debt Relief Act, scheduled to expire at the end of last year, exempts the forgiveness of mortgage debt from being counted as taxable income by the IRS.
The extension of this Act is extremely important to Southwest Florida where many homeowners are underwater, and contemplating a short-sale or loan modification on their home. Without the extension, a homeowner who owes $175,000 on the mortgage and shorts sells for $125,000 would have been taxed on the $50,000, if the lender forgave the entire deficiency. This would have placed the struggling homeowner in a considerably higher tax bracket.
Homeowners need to keep in mind that this legislation only applies to debt relief on their primary residence. Rental property is not included. There are other common situations, however, in which the cancellation of debt is not considered a taxable event. Debts discharged through bankruptcy are not considered taxable income. Further, if you are considered insolvent when the debt is cancelled then some or all of the cancelled debt may not be taxable to you.
Jonathan Bierfeld is an attorney with Martin Law Firm, P.L., whose practice focuses in Bankruptcy Law and Civil Litigation. He is admitted to practice law in the State of Florida and the Federal Court for the Middle District of Florida. He primarily practices in Lee County Florida in Cape Coral and Fort Myers, Florida.