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Dear Liz: I lost my job 18 months ago. I am 61 and have back pain that keeps me from standing more than 15 minutes or sitting more than two hours before I have to lie down, which limits my job prospects. I arranged a short sale of my home a year ago to avoid a foreclosure, and recently received a 1099-C form from the lender for $99,000 of forgiven debt. Please warn others about this!

Answer: Don’t panic just yet.

Normally when a lender cancels or forgives debt, you have to include the forgiven amount in your income for tax purposes, which can result in a whopping tax bill.

But the federal Mortgage Forgiveness Debt Relief Act of 2007 provides an exception for homeowners who lose a home to foreclosure, sell it for less than they owe in a short sale or have their debt reduced through a mortgage modification.

You still have to report the forgiven debt on IRS Form 982, but it’s typically not included in your income for federal tax purposes if:

  • The home was your primary residence (second homes, vacation property and rentals don’t qualify).
  • The forgiven debt was $2 million or less ($1 million for a married person filing separately).
  • The debt was forgiven in calendar years 2007 through 2012.

For more information, visit the IRS’ website at http://tinyurl.com/5pe43f. Details can also be found in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

You’ll have to do a little research to see what you might owe under your state’s income tax laws, which could differ. California, for example, hasn’t updated its law to conform with the federal law for mortgage forgiveness occurring on or after Jan. 1, 2009, although there are several bills pending in the Legislature to do so.

If you’re in California, you might want to bookmark this Franchise Tax Board page at http://tinyurl.com /yhx89zw and check back before filing your taxes April 15 to see if you get any relief.

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you mentioned nothing about the fact that ONLY “qualifying debt”, i.e., wherein the Basis (usually acquisiton + capital improvements) is GREATER than the total loans on the property.

For the tens of thousands of people who have refinanced over the yrs, this is rarely the case!

For example, let’s say the basis is $500K on a house, but the loans are $800K, there is $300K difference …NONE OF WHICH IS “tax free” and has to be declared as ordinary income in the yr that the 1099C was received.


Thanks for your comment, Joan. According to the IRS: “The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.” A tax pro can help suss this out for anyone who’s uncertain.


[...] Ask Liz Weston answers a question on whether or not forgiven home debt could be taxed as income. [...]


This week I happily celebrate my 19th anniversary as a sales account executive for a nationwide collection agency. Does the IRS treat non-payment of debt owed US businesses by consumers as income, a la debt forgiveness, on which addtional tax is due the IRS? If so, how does that amount become income upon which the consumer owes Federal income tax? If not, why not? As a taxpayer, it seems only fair to tax these debtors. Because US businesses typically are able to reduce their own Federal taxes by via writing off bad debt as business expenses.


Interesting point. As you probably already know, unpaid debt doesn’t become potential income to an individual until it is forgiven. The original creditor gets a corporate tax break, typically of around 35%, when the debt is charged off, but there is no corresponding tax bill unless and until some part of the debt is actually erased through forgiveness.


Also don’t forget that for many of these people they can file 982 based on being an insolvent taxpayer (why the legislation was really unnessary other than for high income earners).

As you say check with your tax advisor.