It’s true that sometimes home loan modification or mortgage refinancing is not good enough to save your home from foreclosure. If you have recently lost your home to a foreclosure or short sale, and are now thinking it’s a blessing in disguise, as your outstanding mortgage loan is being entirely Cancelled by your lender, then you are simply building castles in the air. The troubles do not end with cancellation of debt, unpleasant tax consequences follows and the Cancelled debt kicks back in time to time. Cancelled debt is generally considered taxable income by the IRS and you will remain obligated to pay the amount back. However, thanks to the MFDRA (Mortgage Forgiveness Debt Relief Act), passed in 2007, your wish might be granted by Uncle Sam. Under specific situations you might be able to avoid paying taxes on Cancelled debts. Read on to know more in this regard.

Short Sale

Due to the current economic depression or topsy-turvy condition of real estate market sometimes the lender permits borrower to sell the house for less than the mortgage amount. It’s known as short sale. However, the bank sometimes decides to pursue the consumer for this ‘mortgage deficiency’ in court via a lawsuit or sometimes writes off the deficiency as a tax loss. This elimination of debt is better known as ‘cancellation of debt’. Anytime this amount could be retrieved as a business tax deduction.

What’s Covered and What’s not Under the Tax Relief Law

Since the inception of MFDRA (Mortgage Forgiveness Debt Relief Act) consumers are relived from taxes on foreclosure write-offs. However, to find protection under the MFDRA, you need to comply with some stringent conditions. Few of them are given below.

• You must file a form 982 and put forward it to IRA alongside your tax returns.

• Tax relief is only applicable to your principal residence which means the home you live in. In other cases, when the debt forgiveness is for a vacation home or investment property, the amount of debt Cancelled will be regarded as taxable income. The money must be invested to buy, build or substantially renovate the home.

• If your foreclosure debt is more than one million dollars (two million for married couples) you can qualify for a tax relief.

• The debt relief act is enforced upon qualified indebtedness, which indicates only the normally purchased money and/or original acquisition debt on a taxpayer’s home.

• If the debt cancellation occurs between family members and it’s meant to be a gift, it won’t be regarded as a taxable income.

• If the forgiven debt is caused by a Chapter 11 bankruptcy, it would be considered non taxable.

• If the consumer becomes insolvent, during debt cancellation procedure, no tax will be implied upon the Cancelled debt to the extent of the insolvency.

• If the consumer becomes insolvent, during debt cancellation procedure, no tax will be implied upon the Cancelled debt to the extent of the insolvency.

• When student loan debt forgiveness was agreed beforehand, the Cancelled debt won’t be subjected to tax implications.

• When student loan debt forgiveness was agreed beforehand, the Cancelled debt won’t be subjected to tax implications.

• If both parties the seller as well as the purchaser comes to an agreement that the reduction in debt is a modification to the purchase price then the debt won’t be taken as a taxable income.

To conclude, it’s not very easy to analyze the tax impact of your Cancelled debt, therefore, make sure you keep in mind the aforementioned points and look for a qualified and experienced tax professional’s help as and when required.