New Rules on Cancellation of Indebtedness Income Related to Mortgages

Q: What are the new rules if you default on your mortgage and the bank forgives your mortgage?
Jennifer

A: Congress recently passed H.R. 3648, the "Mortgage Forgiveness Debt Relief Act of 2007."  Under tax rules, most debts that are forgiven to you are considered income to you, and taxable.  There are exceptions under the law to this general rule, the most common of which is debt forgiveness done under a bankruptcy settlement.

This law would, from 2007 through 2009, add to that list of exceptions a mortgage which is forgiven on your principal residence.  The amount of debt forgiven reduces your basis in the home.  Only $2 million of mortgage debt is allowed to be excluded.  The forgiveness must be related to the decline in value of the home or the diminished financial condition of the taxpayer. 

The bill also extends the deduction for private mortgage insurance (PMI) through 2010 and allows spouses to claim the full $500,000 capital gain exclusion on the sale of a principal residence up to two years after the death of the other spouse.

Comments

[Darrin Mish]

What a lot of people (including Congress I guess) is that there has long been a loophole in the law that allowed taxpayers who were "insolvent" to get around paying the taxes on a forgiveness of debt situation including foreclosures. Of course, this is a good bill and nice for people who have lost their homes to be better informed that they have not also created a giant IRS Problem. I applaud Congress for passing legislation that actually helps real people.

[janet]

i moved out of my home and began living w/ my boyfriend in his apartment in the hopes that if my house was move-in ready, it would sell faster. well it didn't sell and now it is foreclosing. the new law says it applies to "principal residence." can i still get the tax relief?