New tax legislation signed into law on December 20, 2007 provide for homeowners who partially or entirely had mortgage debt forgiven during 2007 to possibly be able to claim special tax relief.
Normally debt forgiveness results in taxable income in many cases with very few exceptions. Under the Mortgage Forgiveness Debt Relief Act of 2007, enacted late last year taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was less than $2 million. The limit is $1 million for a married person filing a separate return.
The new law applies to mortgage debt forgiven in 2007, 2008 or 2009. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, may qualify for this relief.
The debt must have been used to purchase, build or substantially improve the taxpayer’s principal residence and must have been secured by that residence.
An important but easily missed issue is that refinanced debt possibly may not be subject to tax relief. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just prior to refinancing.
Debt forgiven on second homes, rental property, business property, credit cards and car loans do not qualify for the new tax-relief provision. There are other provisions in prior tax law that apply to other types of debt forgiveness and tax relief, based on insolvency, or bankruptcy.
Any borrower that had debt reduced or eliminated should receive a year-end statement (Form 1099-C) from the lender that forgave or restructured any such debt.