Loan Modification

Tax Fact 2-Mortgage Debt Forgiveness Exclusion Financial Limits

By Kent Anderson, Oregon Bankruptcy Attorney

In order to qualify for full exclusion from income when debt is cancelled on the taxpayer?s principal residence, the amount of debt cancelled cannot be more than two million dollars for a married couple or individual; or if an individual is married but filing a separate return, the debt cancelled cannot be more than one million dollars.  Even in California that would be a pretty big house.  The two million dollar limit does not refer to the amount of the home loan, the limitation is only applied to the amount of debt cancelled or forgiven.  The amount of debt cancelled is calculated by subtracting the fair market value of the principal residence from the amount of debt secured against it at the time of cancellation.           

Debt cancellation on a principal residence can occur in a number of different ways.  The most common way people will see this occur is when there is a foreclosure.  In a foreclosure sale, the property is often sold at a value which is less than the amount of the debt.  This will cause cancellation of debt income. 

Another situation in which mortgage debt forgiveness can occur is a short sale.  While that term has long been used in describing certain stock transactions, it has gained popularity in describing the sale of a property for less than the amount of debt secured against it.  When that happens, the lender is paid a ?short? amount and does not get paid the remainder of the debt.  For debt cancellation to occur, the lender would have to forgive the amount it failed to receive in exchange for the release of its lien.  This type of transaction has become a common practice when lenders want to avoid the cost of foreclosure.  A homeowner is generally able to sell their residence for more money than it would bring at a foreclosure sale.

Related posts:

1. Tax Fact 1-The Mortgage Forgiveness Debt Relief Act of 2007
2. Ten Tax Facts About Mortgage Forgiveness
3. Short Sale May Cause Problems

Full post as published by Mortgage Law Network on March 11, 2010 (boomark / email).