Mortgage Foreclosure and Related Tax Consequences (Tax Relief)
Losing your home through mortgage foreclosure can be a stressful event. You may have many things on your mind related to the mortgage foreclosure process, the least of which could be the tax implications of having your debt discharged or forgiven on your primary place of residence.
Under certain circumstances, cancelled debt from a lender or creditor can be designated as taxable income. When you borrow money or fail on your obligation to repay a lender, and that obligation is then forgiven (the lender cannot collect from you), the cancellation of the remaining debt or proceeds is reportable income because you are no longer required to repay such money. In turn, you are liable to pay taxes on the amount of money that you have been forgiven for in connection to a debt.
However, when dealing with mortgage foreclosure, there is good news if the debt or loan that was forgiven was in connection with purchasing your home or residence. In fact, you may not have to pay taxes at all.
What is a 1099-C and when do you get one?
A 1099-C form is an indication that an organization, including but not limited to a commercial lender, credit union or finance institution, has discharged a debt that you owe. Creditors who forgive more than $600 worth of debt are required to file a 1099-C with the IRS. If this event occurs and a debt you owe is discharged, you will likely receive a 1099-C form in the mail. Unless you meet an exception or exclusion, your cancelled debt must be reported as income and you will be liable to pay taxes on such income. In turn, you will be required to file the 1099-C form with your federal tax return.
The form itself consists of a few entries comprising of less than a page worth of information, generally detailing the names of the parties involved and a description of the debt involved and monies owed/forgiven. Three copies are included with the 1099-C, one each for the IRS, creditor and debtor.
Exclusion to Owing Taxes on Cancellation of Debt (COD)
If you receive a 1099-C form and notice of COD, do not ignore it and do not panic.
As briefly discussed above, the mortgage foreclosure on your home may result in your loan being discharged and deemed as cancelled debt. However, if your cancelled debt is excluded from your income, you do not need to pay taxes on it.
If you took out a loan or mortgage to purchase a home and the lender’s only legal remedy in case of default is to repossess the property being used as collateral for the loan (a non-recourse loan), you are not personally liable. As a result, the forgiveness of the loan related to mortgage foreclosure does not result in cancelled debt income that is taxable. This is otherwise known as Qualified Principal Residence Indebtedness.
Therefore, if your situation applies to the Qualified Principal Residence Indebtedness, you may be able bypass having to pay taxes on your Cancellation of Debt altogether and claim an exclusion.
To ensure you qualify for the exclusion to taxable income, the following criteria must be met:
- The debt must have occurred after 2006;
- The debt must have been used to purchase, build, or significantly renovate your principal residence (refinanced debt also applies only insofar as it was used to improve your residence and secured by such residence);
- The debt can be from a mortgage that was foreclosed upon, a short sale or a deed in lieu of foreclosure;
- The discharge provided by the lender can only be due to a decline in the value of the residence or due to your financial condition regarding repayment;
- Your principal residence is your main home in which you live most of the time. Note that you can only have one main home at a time. This does not apply to a vacation home or property you rent to others; and
- If you qualify for your debt to be excluded from tax, the limits are capped at $2 million ($1 million if married and filing separately).
Further, the initial act (The Mortgage Forgiveness Debt Relief Act of 2007) regarding the Qualified Principal Residence Indebtedness applied to mortgage debt forgiven in the years from 2007 to 2010. Initially, this exclusion was extended through the year 2017. Currently, the latest addition to this exclusion applies to debts discharged before January 1, 2021 or for debts forgiven as a result of written agreement before January 1, 2021, even if the discharge occurs after.
How to Claim the Exclusion to the 1099-C Notification and Avoid Tax Penalties
If you are able to claim an exclusion to the 1099-C, you must file a 982-form evidencing that you can claim an exclusion. The 982-form details the possible exclusions you can claim, including the Qualified Principal Residence Indebtedness provision. This form must be attached your tax return for the tax year in which the debt was forgiven.
What if I Win a Mortgage Foreclosure Lawsuit?
If you win your mortgage foreclosure defense suit, you can avoid the issue of a 1099-C. If creditors or lenders are not able to produce all the necessary documentation required by court and legal proceedings, you may be entitled to a judgment in your favor.
The creditors must produce and verify all the financial and foreclosure information (such as the originally promissory note or supporting evidence showing the borrower agreed to the terms of the loan) to bring and win a proper mortgage foreclosure suit. If they fail to do so, the foreclosure can be dismissed. As a result of a dismissed case, there are no debt obligations and the requirements of 1099-C cease to exist.
Further, by forcing th lender to produce all necessary documentation in court, you also effectively delay the foreclosure proceedings. This can provide you with time to work out additional relief measures with your lender or improve your financial position in the meantime.
Consult Us Regarding Your Mortgage Foreclosure and Cancellation of Debt
If you are a Pennsylvania citizen who is in the process of having to go through a mortgage foreclosure regarding your home and have further questions regarding the taxes you may or may not owe, the talented mortgage foreclosure attorneys at the Law Firm of Fenters Ward are here to help. Do not hesitate to contact us by filling out our contact form or calling 877-259-WARD.
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