Tax Relief, Tax Help

Homeowners whose debt is forgiven under Treasury’s “Making Home Affordable” initiative may be entitled to tax relief

Relief for Responsible Homeowners: Treasury Announces Requirements for the Making Home Affordable

Mike Habib, EA Tax Relief & Tax Problem Resolution

On Mar. 4, Treasury release the first details on two programs designed to offer mortgage relief to struggling homeowners, “Home Affordable Refinance” and “Home Affordable Modification.” Although the focus of the latter program is to reduce interest rates on at-risk loans and thereby reduce mortgage payments, one possible modification is a reduction of home loan debt. Fortunately, under a law enacted late in 2007, reduction of qualified home mortgage debt shouldn’t have tax consequences to the homeowner.

Mortgage debt forgiveness relief. In general, a taxpayer realizes income when debt is forgiven. There are several exceptions and exclusions that may result in all or part of a taxpayer’s income from the cancellation of debt being nontaxable. Under the Mortgage Relief Act (P.L. 110-142), which was initially effective for indebtedness discharged on or after Jan. 1, 2007 and before Jan. 1, 2010 and which was later extended three additional years, through 2012, by the Emergency Economic Stabilization Act of 2008), taxpayers may exclude up to $2 million of qualified principal residence debt. (Code Sec. 108(a)(1)(E)) The exclusion is claimed by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), and attaching it to the taxpayer’s applicable income tax return.

Qualified principal residence indebtedness is acquisition indebtedness under Code Sec. 163(h)(3)(B) with respect to the taxpayer’s principal residence, but with a $2 million limit ($1 million for married individuals filing separately). (Code Sec. 108(h)(2)) “Principal residence” has the same meaning as under the homesale exclusion rules of Code Sec. 121. (Code Sec. 108(h)(5)) Acquisition indebtedness of a principal residence is indebtedness incurred in the acquisition, construction, or substantial improvement of an individual’s principal residence that is secured by the residence. It includes refinancing of debt to the extent the amount of the refinancing doesn’t exceed the amount of the refinanced indebtedness. (Joint Committee on Taxation JCX-86-07)

The basis of the taxpayer’s principal residence is reduced by the excluded amount, but not below zero. (Code Sec. 108(h)(1))

If any loan is discharged, in whole or in part, and only part of the loan is qualified principal residence indebtedness, the mortgage forgiveness exclusion applies only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before the discharge) which is not qualified principal residence indebtedness. (Code Sec. 108(h)(4))

The exclusion doesn’t apply to the discharge of a loan if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the taxpayer’s financial condition. The exclusion also doesn’t apply to a taxpayer in a Title 11 bankruptcy. (Code Sec. 108(h)(3)) An insolvent taxpayer (other than one in a Title 11 bankruptcy) can elect to have the mortgage forgiveness exclusion not apply and can instead rely on the Code Sec. 108(a)(1)(B) exclusion for insolvent taxpayers. (Code Sec. 108(a)(2))

In IR 2008-17, IRS noted that debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, can qualify for the Code Sec. 108(a)(1)(E) relief. But, debt forgiven on second homes, rental property, business property, credit cards or car loans doesn’t qualify for this tax-relief. In some cases, however, other kinds of tax relief (e.g., based on insolvency) may be available.

Get tax relief and resolve your tax matters by contacting the tax firm of Mike Habib, EA at 877-788-2937 or online at

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