Avoid Paying Tax on Cancellation of Debt on Your Home Mortgage

If you let your home go back to the lender and you owe more on the loan than the settlement amount the lender accepts, the difference is forgiven by the lender, but the federal government can tax you on the difference unless you qualify for either of two currently available home mortgage cancellation of debt exclusions.  With the downturn in the economy and the accompanying drop in home prices that occurred in recent years, many taxpayers are unable to keep up with the mortgage payments on their home, and unable to sell their homes because they owe more than the market price.  As a result, a large number of homeowners have let their homes go back to the lender.

Congress offered help for those in this situation by providing an exclusion from income of the forgiven acquisition debt from a taxpayer’s principal residence.  If a taxpayer’s home is upside down, and they are considering letting it go back to the lender, they should be aware that unless Congress provides a last-minute extension, this Principal Residence Acquisition Debt Relief Exclusion will expire at the end of 2013.  The only other exclusion available is the insolvent taxpayer exclusion, which limits the amount that can be excluded to the excess of the taxpayer’s total debts over the taxpayer’s total assets.

An individual not able to exclude the forgiven debt on their home using the insolvent taxpayer exclusion may wish to act before year’s end.  The tax implications of forgiven debt are very complicated and not all the details are covered in this article.

If you are considering this, we strongly urge to contact us at 559.924.1225 to review all your options and their tax implications.