What I wanted you to know about is the Mortgage Forgiveness Debt Relief Act of 2007. That covers the calendar years 2007 through 2012 and it has to do with taxpayers who have had foreclosures on their primary residences. Up to $2 million of forgiven debt can be included if it had to do with the sale (or the foreclosure) of your principal residence. The amount excluded reduces your taxpayer’s cost, or the taxpayer’s cost basis on the house. It’s important to know that. Click here to read or watch more IRS Help resources.
If you want more information on the Mortgage Forgiveness Debt Relief Act of 2007, you need to check into IRS Publication 4681 for more information on this particular act.
The idea is that the Congress did not want to add insult to injury for people who had actually gone through foreclosures in these trying economic times and have large tax bills be created through the cancellation of this date. Prior to 2007, this was actually a problem for lots of people.
Let’s talk about the old offer just a minute because it might actually help. Such canceled debt was taxable prior to the passage of the law in 2007, but there were some pretty big exceptions; in my opinion, exceptions that you could drive a truck through.
Number one was bankruptcy. If you had debt canceled as a result of a bankruptcy, well obviously and intuitively you know that that debt couldn’t be then considered canceled debt and subject to income tax; otherwise, bankruptcy would create a large tax problem every single time. So that was a pretty big exclusion.
The next one – the one that I think is even bigger for people who had gone through foreclosures was if you could demonstrate that the taxpayer was insolvent at the time of the cancellation of the debt, then the debt was not actually considered taxable income. And the reason I wanted to explain this old rule was because that’s the exception that you can drive a truck through. You see, even if you had a foreclosure on a non-principal residence, if you could demonstrate to the IRS and oftentimes, you don’t even have to demonstrate it, you just have to assert it – if you can asset and demonstrate that you were actually insolvent to the time and the forgiveness of debt, the IRS is not going to consider that taxable income. This is huge! It’s huge!
Just for a minute, let me go over the other two exceptions. There are certain farm debts that when canceled are not going to be considered taxable income and non-recourse debt that’s not canceled is not going to be considered a cancellation of debt.
What does non-recourse debt mean? Non-recourse debt is where the loan was made solely on the back of collateral. For example, you got a car loan and for whatever reason, there was no personal guarantee; their only recourse was to recover the collateral, then that sort of non-recourse debt is not considered cancellation of income.
Now, you need to look at IRS form 982 for these types of cases. The form can be a little bit complicated. If you need help explaining that, then you need to contact your tax professional, or you can contact my office. It says Publication 982 on this slide, there is actually form 982. It is often going to save you a tremendous amount of money when it comes to the topic of cancellation of debt or forgiveness of debt.