IRS Taxes and Mortgage Debt Forgiveness

Stephen Ganns,, discusses IRS Taxes and the specifics of mortgage forgiveness debt.Unfortunately, in this day and age many people find themselves with their houses, as we say, “under water”. They owe more than the house is worth. People also find mortgage payments starting to fall behind due to the homeowner or the homeowner’s spouse having lost their job, or an unforeseen expense such as a medical emergency. What may happen when the mortgage is in arrears is the couple or the single owner may end up walking away from the home or do some kind of mortgage modification where the mortgagor, depending upon the situation, forgives part or all of the debt. Unfortunately, in many cases the forgiveness of mortgage debt can turn into taxable income for the owner, but there are some exclusions.

The most common exclusion is if the home is a personal residence and you have used the debt to buy, build or substantially improve that residence, which is secured by that mortgage, then the whole amount up to $1,000,000 for a married filing separate return or $2,000,000 on all other returns, would not be taxable. So it will not be considered income by the IRS if:

  • If you owe the bank or mortgage or less than $2,000,000
  • If it is your primary home
  • If your mortgage debt has been either completely or partially forgiven

it will not be considered income by the IRS.

The important thing here is that the debt must be to purchase, improve or build the original home. If someone has refinanced their home a few times to send kids to college or used that money to buy a second home, etc., that portion of the debt would not be exempt from taxation. So, let’s say your mortgage debt is on a second home or that you used it for other things, therefore your mortgage debt is not excluded by the primary residence exclusion. However, there is still a possibility that it might not be subject to tax.

What you would need to do is file an IRS Form 982, which allows you to possibly offset this “debt forgiveness” income if you are deemed to be insolvent. Let’s say you have two homes, and the mortgage debt was cancelled on both because you and your spouse both lost your jobs. You’ve gone through all your savings and retirement accounts trying to keep up with the payments, but both mortgages foreclose. As explained above, the mortgage on your primary home would not be subject to tax, however, the mortgage on the other home might be subject to tax. But if you are found to be totally insolvent, you would not have to pick up income on the second home loan either. The Form 982 instructions define insolvency for IRS purposes.

In all cases, you will get a form 1099C from your lender. If you are unfortunate enough to be in one of these situations, please make sure you talk to your tax consultant, accountant or tax preparer. Go over all these possible exclusions, otherwise, on top of the tragedy of having to walk away from your home, you may also have to pay additional income tax.

Stephen J. GannsStephen J. Ganns, CPA


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