Do You Have To Pay Tax On Forgiven Mortgage Debt?

If a house is sold either through a foreclosure auction or short sale and the amount that is fetched from the sale is less than the amount the borrower owes to the lender, what happens to the remaining balance? This largely depends on the amount, but if substantial the remaining balance may be transferred into an unsecured credit agreement that the borrower will still be expected to pay. However, on occasions lenders are willing to write off the remaining balance as they are just happy to recoup the majority of their money.  Under these circumstances, in the eyes of the tax man this forgiven debt is classed as a form of income, even though no money has actually passed through your hands. So do you have to pay tax on this “income”? At the moment the answer is no in a majority of cases thanks to the Mortgage Debt Relief Act of 2007.

Mortgage Debt Relief Act (2007)

If you have suffered financial woes from 2007 to 2012 and unfortunately lost your home, this act allows mortgage debts which are forgiven to go untaxed in a majority of cases. Below is a short list of the specifics which this act covers.

• The act states that any debt forgiven on a person’s primary residence, up to a maximum of $2 million, will not be subjected to usual taxation. If you own a mansion and lose it to foreclosure though, you could be in for a pretty hefty tax bill come the year end.
• Only debts that are written off between 2007 and the end of 2012 will be affected by this act.
• The money which is still owed must have been borrowed in order to purchase, construct or make improvements to a primary residence.
• If the debt was forgiven on an office, investment property or holiday home, you will not be covered by this act and the amount forgiven will be added to your taxable income.
• If you refinanced your mortgage as you needed to free up some cash for purchases not related to the improvement of your home, this money will still be subject to income tax.

When you’ve just suffered at the hands of a foreclosure and are trying your best to rebuild your life, the last thing you need is a bigger tax bill. This act has served to provide relief to people in that very situation, but will unfortunately expire at the end of this year.

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