Do you have a Recently Forgiven Loan? Know the Limitations and Effects it may have on your Taxes
If a debt is forgiven, the amount forgiven is considered by the IRS [US Internal Revenue Service] to be taxable income. If you have been involved in a short sale or some other work-out of a foreclosure, you may have received a 1099-C reflecting a ‘forgiveness of indebtedness” or, in other words, the bank has released you from any personal liability on the loan. (This means lender can not pursue a deficiency judgment.)
Capital Gains Tax and the Recently Extended Mortgage Forgiveness Debt Relief Act
Created in 2007, the Act has provided homeowners a tax exemption when they obtain debt forgiveness on a primary residence. * Under the IRC a home is a principle residence if used as such for 2 of the preceding 5 years. Passed January 1, 2012, as part of the American Taxpayer Relief Act of 2012 (fiscal cliff bill), a one-year extension has been approved for the Mortgage Forgiveness Debt Relief Act (the Act).
Many of you already know that Congress has said that if the mortgage was for your principal residence [Florida homestead], you don’t have to pay that tax. However, few actually look closely at what Congress really said. It only applies to a wipeout of a debt (up to $1 million for an individual, $2 million for a couple) occurring after January 1, 2007 and before January 1, 2013, now extended to January 1, 2014. In other words, forgiveness must occur by the end of 2013.
Further, it only applies to a mortgage taken to purchase the property OR to make substantial improvements. It does include refinancing of these loans to the extent the refinancing does not exceed the original amount borrowed. This is a critical point since so many people drew money out of their home to speculate in the real estate market or use for other purposes.
The Act does NOT include borrowing used for such other, personal purposes. It does not include mortgage or HELOC (Home Equity Line of Credit) money used to buy other properties or for any purposes other than for the primary residence. You may still be covered if it was a refinance that was used at least partly to pay off a previous loan that was used to purchase or improve the property. Be aware of the differences. There is talk that the IRS may be auditing, so discuss this carefully with your CPA.
This is not the only exclusion that you can use, your CPA or tax attorney can advise you of other options. Do have a CPA do your tax return if you are claiming one of these exclusions…don’t be penny wise and pound foolish.
As a consequence of the settlement entered into recently by the Attorney Generals of 49 states, many people are receiving notices that their loan has been completely forgiven. Those notices do not indicate whether the lender will be sending a 1099-C. This could be problematic for the borrower. Technically, only a 1099-C permits you to exclude that amount from income on your IRS tax return. }. I have heard that some CPAs are treating any 1099 as a forgiveness, it’s too early to say how the IRS is responding to this. If you have received such a letter, you should review it with your own tax advisor and with a licensed Florida attorney such as myself, Celia E. Deifik, to craft an appropriate response.