Your Bank Forgave Your Mortgage Debt, but Will the IRS?

According to the Internal Revenue Service, those who have debts that have been forgiven may have to pay taxes on the forgiven amount. That comes as a surprise at tax season when homeowners who have received a mortgage cancellation or forgiveness also receive a dreaded 1099C, entitled Cancellation of Debt, in the mail.

What is canceled mortgage debt? In this circumstance, canceled or forgiven debt applies to loan modifications that resulted in a reduction of the amount of debt owed, as well as forgiven mortgage debt that occurred due to foreclosure.

Does a homeowner have to pay taxes on mortgage debt that's been forgiven or canceled? Some reduced or canceled debts do have to be treated as income, but not all. It depends on their circumstances and the amount of debt. The federal government, knowing that taxing cancelled mortgage debt is like rubbing salt in a wound, established the Mortgage Forgiveness Debt Relief Act in 2007 to provide guidelines for the kind and amount of canceled debt that is taxable, and providing exclusions which can save you from having to pay taxes on some forgiven debts.

In most cases, the Act excludes mortgage forgiveness, reduction, or cancellation from taxation. However, there are restrictions, and you need to be aware of what they are in order to know if you have to claim the forgiven debt as taxable income. The basic qualifications for exclusion include:

  • The forgiven debt must be on your principal residence (rental and business properties do not qualify).

  • The amount forgiven must exceed $600 (lesser amounts do not qualify).
  • The debt must have been forgiven between 2007 and 2012.
  • The amount excluded is limited to $2 million. If married filing separately, that amount drops to $1 million (any amount over those limits are subject to taxation).
  • Bankruptcies are also included in this Act, which states that "debts discharged due to bankruptcy are not considered taxable income." The forgiven or canceled amount of second mortgages and funds used to refinance a principal residence are also viewed as non-taxable, but the amount cannot exceed the amount of the original (first) mortgage before refinancing. In addition, the debt must be secured by the property and must have been used to buy, build or improve the home. For example, if John Doe used the equity in his home to secure a second mortgage in the amount of $30,000, but used $10,000 to pay off his credit card debt, the $10,000 is taxable because it wasn't used to buy, build or improve his residence.

    For more information on mortgage forgiveness in first or second mortgages and refinances, see Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. Additional information can be found in the IRS news release IR-2008-17.

    Do you still have to report the cancelled debt, even if it qualifies for exclusion? Yes. If your canceled debt is $600 or more, your lender is required to send you Form 1099-C, Cancellation of Debt. The amount of debt canceled can be found in Box 2 of this form. Your lender also reports this amount to the IRS.

    To report canceled debt on your income tax return, you'll need to attach Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to your return. It's a relatively simple process. Those with canceled mortgage debt due to foreclosure only have to complete lines 1e and 2. Those who received a reduction in debt due to loan modification should complete lines 1e, 2, and 10b. The form can be downloaded at the link above or by visiting Those who wish to receive Form 982 by mail should call 1-800-829-3676.

    If you don't believe that the cancellation of your mortgage debt qualifies under this Act, there is still hope that you won't have to pay income tax on that amount. The Act also states that canceled or forgiven debt due to insolvency may apply. Insolvency simply means that you have more debt than assets. If your total debt exceeds the value of all your assets, you are considered insolvent. Form 982 is used to claim this exclusion, too. Again, you don't have to complete the entire form -- to claim insolvency, you need to check Box 1b. Determine the amount of canceled debt and the amount by which you were insolvent (total debts minus total assets). Insert the smaller of those two figures on Line 2 of Form 982.

    By following the instructions and completing Form 982, you can take advantage of this opportunity to avoid having to pay taxes on your forgiven mortgage debt. Reporting that debt is required, regardless if your debt qualifies as an exclusion or not. If you're unsure if you qualify, you can contact a tax professional or call the IRS tax assistance line at 800-829-1040.

    Anna Cuevas, known as "America's Loan Modification Guru," has guided thousands of Americans in keeping their homes from foreclosure. A popular blogger (, Cuevas has been called a "superhero of the loan modification industry". She is the #1 bestselling author of
    SAVE YOUR HOME Without Losing Your Mind or Money and Fight For Your Dreams with Les Brown.