Your Mortgage Debt Was Forgiven, But Do You Owe Tax On That?

Some homeowners have been able to negotiate their way out of underwater mortgages and have emerged free and clear, due to short sales, foreclosures and other options that they may have had available for their situation.
Or have they?
If you managed to get out of a bad mortgage, you do need to confirm you don’t run afoul of the IRS by failing to pay any applicable tax on that loan forgiveness.
Cancellation of Debt
When a bank or other lender forgives a debt, some accounting must be considered. A loan does not qualify as income, because you have to repay the lender with interest, so that money “costs” you.
If the loan is forgiven, the amount “cancelled” can be counted as income, as you received money and did not pay it back. This seems particularly unfair in the context of underwater mortgages; given the property is no longer worth the original loan value, but the “gain” is based on the loan value.
The Mortgage Forgiveness Debt Relief Act
Congress recognized that for many people, if you are in a financial circumstance that necessitates a cancellation of debt, receiving a tax bill for the mortgage forgiveness, might not feel appropriate.
The Mortgage Debt Relief Act of 2007 to allows taxpayers to avoid liability for the “income” resulting from the discharge of debt on your principal residence.
To be eligible, the debt forgiveness must have occurred from 2007 through 2012.
The debt must be related to a “decline in the home’s value or the taxpayer’s financial condition.” $2 million may be forgiven ($1 million if married filing separately.)
Equity loan debt qualifies, but only if the proceeds were used for improvements to the home. If you used a $20,000 home equity loan for paying off credit card debt or buying a car, it cannot be excluded from your income tax.
When doing your taxes, you will now if you have potential debt forgiveness income if your received the IRS Form 1099-C, Cancellation of Debt from your lender.

Warwick’s bankruptcy teaches lessons to Indiana residents

A recent filing by Grammy Award-winning singer Dionne Warwick proves that anyone can end up in the financial situation where bankruptcy is the best possible debt relief option. The hope for Warwick, 72, is that this bankruptcy filing will allow her to once again take control of her finances.
When looking at what happened to cause the 72-year-old to file for personal bankruptcy , her publicist said her debt is due to “negligent and gross financial mismanagement.” This mismanagement reportedly went on from the 1980s until the mid-1990s.
In her bankruptcy filing, Warwick lists assets at $25,500, while liabilities reach more than $10.7 million. Of the more than $10.7 million, the Internal Revenue Service is listed. This is supposedly due to the fact that while she did owe in back taxes, she has paid up what was owed. However, penalties and interest have continued to pile up, and even though the singer has tried to make payment options with the IRS, an agreement could not be reached.
In looking at this recent bankruptcy filing, there are certainly lessons the average Indiana resident can learn. The first being that debt can happen, even to those with a decent income who think they are financially responsible.
When debts do get out of control, as Warwick’s filing goes to show, bankruptcy is often an option. Depending on the type of filing this can result in debts being discharged or a repayment plan being established. If repayment is the route, filers typically have between three and five years to pay back what is owed.
Lastly, keep in mind that those who are thinking of filing for bankruptcy should talk with an attorney who specializes in debt relief in Indiana. This attorney can help explore different options to maximize the benefits of bankruptcy.