Through the Mortgage Debt Relief Act of 2007, taxpayers are able to exclude income from the discharge of debt on their main home. Homeowners who have either mortgage debt that has been forgiven as a result of a foreclosure or decreased debt as a result of mortgage restriction are eligible for relief. Homeowners who had debt forgiven between 2007 and 2014 qualify for up to $2 million of this exclusion. However, if the discharge of debt isn’t directly related to the home’s decreased value or the homeowner’s financial status, the exclusion won’t apply.
Here are some of the important points concerning the cancellation of debt.
What is the Cancellation of Debt?
You aren’t required to report the income from a loan you receive from a mortgage lender when you file taxes because you have to repay it. If a mortgage lender happens to forgive or cancel the debt, though, you would have to report it. In this case, the mortgage lender would use a 1099-C form to report the amount of debt it has canceled to both you and the Internal Revenue Service.
Example: If you borrow $50,000 and default on the loan after repaying the lender $10,000 of it, there will be a cancellation debt of $40,000 that could be taxable.
Is Cancellation of Debt Income Always Taxable?
In certain situations, the IRS doesn’t tax income from the cancellation of debt. This happens if the debt was discharged through bankruptcy, canceled when you were insolvent, incurred while you were operating a farm, or associated with a non-recourse loan.