If you are in current financial stress then you may be familiar with the various forms of mortgage debt forgiveness. When it comes to mortgage debt forgiveness there is both a Federal law and State law that of course vary from state to state. Often times the Federal law and state laws will vary wildly. If you have questions about mortgage debt forgiveness it is important that you check both the Federal law and various State laws.
What is the cancellation of debt?
If an individual borrowers is loaned money from a commercial lender and the lender happens to cancel or forgive this debt, then the amount of debt canceled may have to be included as income for tax purposes, depending on the situation. This is not considered income when you first borrowed the funds because you had a responsibility to repay the loan. When the lender forgives this responsibility, than it is to be reported as income because you are no longer obligated to repay the debt. Lenders will typically serve the borrower with a 1099-C (cancellation of debt) for the amount forgiven.
With the federal Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayer to exclude income from the release of debt on their residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for relief as outlined by the federal law. What this means is that if you were forced into selling your home as a short sale the amount of the debt that was forgiven by the lender is typically treated as income. In previous years that forgiven debt that is treated as income would be taxable by the IRS. This is no longer the case with the Mortgage Forgiveness Debt Relief act of 2007. Tax payers can now deduct up to $2 million in debt forgiveness if they sell their house as a short sale.
However, for discharges occurring on or after January 1, 2009 California does not conform to the federal provision. Generally speaking the amount of debt released is taxable to the state of California. California differs from the Federal law in that homeowners who are given some form of debt forgiveness are still required to pay taxes on the amount the lenders forgave. Since this amount is treated as income the state of California still requires you to pay income tax on this amount while the Federal government does not. However, several bills pending in the state legislature would extend and modify California mortgage forgiveness debt relief to conform more to the Federal law. This would be a welcomed addition to California’s version of the Mortgage Forgiveness Debt Relief Act and certainly would help out a lot of home owners who have had to sell their houses as a short sale.
Since California state law differs from the Federal law there are many different forms you will need to fill out when looking to claim mortgage debt forgiveness. Also, these forms will differ for the state of California depending on what year you are filing your tax return. It is best to consult a tax expert when doing your taxes if you recently sold your home in California as a short sale. By consulting an expert you will make sure that you file all of the necessary forms and pay all of the necessary taxes so that you do not fall further into debt or even worse have the IRS garnish your bank accounts.
If you feel that the information on the 1099-c is incorrect you need to contact your lender right away to get the mistakes fixed. Retain all of your original loan documents and any other information related to this issue. Once you prove that the information on the form is not accurate the lender should go back and redo the 1099-c.
What happens if I cannot afford to pay taxes on the canceled debt?
Be aware that if you cannot afford to pay taxes on the forgiven amount it will not magically disappear. You will have to pay one way or another. The IRS urges anyone that cannot afford to pay this to try and set up a payment arrangement with the agency right away to avoid any further consequences.
Check out the IRS website to find out more about this act.
