Karen A. Hahn CPA
DEBT CANCELLATION
A provision of the Internal Revenue Code, Section 108 for those of you who care, has become much more important to people since the great real estate melt down of 2008.
First the general rule:
Debt that has been cancelled or forgiven is taxable income. This includes credit card balances, car loans, personal loans, and yes mortgages on real estate.
This "forgiveness" of debt is reported on line 22 of the first page of the Indiviudal Tax Form 1040.
Creditors are requried to send the IRS a form 1099C if the forgiven debt is more than $600.
There are three exceptions to the general rule.
You are insolvent immediately before the debt is cancelled.
You have claimed bankruptcy.
Your personal residence has been foreclosed and you have received a cancellation of debt.
INSOLVENCY
You are insolvent if your total debt exceeds the total fair market value of your assets on the date the debt was cancelled. Make a list of all your assets and their fair market value. Then make a list of all your liabilities. If the total of your liabilities exceed the value of your assets you are insolvent and can exclude part or all of the forgiven debt.
Exception to the Exception
You can only exclude cancelled debt up to the amount of insolvency.
For example, $10,000 of charge card debt was cancelled by Visa company on 6/30/08. At 6/30/08 you owned a personal residence which was worth $350,000. The mortgage on the house was $348,000 plus $10,000 of credit card debt brings total liabilities to $358,000 You have no other assets or liabilities. You are insolvent in the amount of $8,000. You may exclude $8,000 in debt forgiveness and you must report $2,000 in taxable inocme on your tax return.
BANKRUPTCY
If you have debt cancellation as a result of filing bankruptcy, the debt cancellation is not taxable.
PERSONAL RESIDENCE MORTGAGE RELIEF
Under the Mortgage Forgiveness Debt Relief Act of 2007, enacted Dec. 20, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was less than $2 million. The limit is $1 million for a married person filing a separate return.
The new law applies to debt forgiven in 2007, 2008 or 2009.
The debt must have been used to buy, build or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.
CALIFORNIA LAW
California mortgage forgiveness debt relief law is effective immediately. It is similar to federal law, but with important differences. The California law covers qualified debt forgiven in 2007 and 2008, and it:
Limits the amount of qualified principal residence indebtedness to $800,000 for taxpayers who file as married/registered domestic partners (RDP) filing jointly, single, head of household, or widow/widower, and to $400,000 for taxpayers who file as married/RDP filing separately.
FORMS YOU SHOULD KNOW ABOUT
The creditor will send you form 1099c and will also send this form to the IRS. You should examine the numbers reported on the form and make sure they are correct.
You will need to file form 982 with your federal and state return. If you are claiming insolvency, you will need to attach a statement to your return showing why you are insolvent.
SEEK PROFESSIONAL ASSISTANCE BEFORE YOU COMPLETE THE TRANSACTION
Contact us for more information, for calculations, and for help with completing the forms.
A provision of the Internal Revenue Code, Section 108 for those of you who care, has become much more important to people since the great real estate melt down of 2008.
First the general rule:
Debt that has been cancelled or forgiven is taxable income. This includes credit card balances, car loans, personal loans, and yes mortgages on real estate.
This "forgiveness" of debt is reported on line 22 of the first page of the Indiviudal Tax Form 1040.
Creditors are requried to send the IRS a form 1099C if the forgiven debt is more than $600.
There are three exceptions to the general rule.
INSOLVENCY
You are insolvent if your total debt exceeds the total fair market value of your assets on the date the debt was cancelled. Make a list of all your assets and their fair market value. Then make a list of all your liabilities. If the total of your liabilities exceed the value of your assets you are insolvent and can exclude part or all of the forgiven debt.
Exception to the Exception
You can only exclude cancelled debt up to the amount of insolvency.
For example, $10,000 of charge card debt was cancelled by Visa company on 6/30/08. At 6/30/08 you owned a personal residence which was worth $350,000. The mortgage on the house was $348,000 plus $10,000 of credit card debt brings total liabilities to $358,000 You have no other assets or liabilities. You are insolvent in the amount of $8,000. You may exclude $8,000 in debt forgiveness and you must report $2,000 in taxable inocme on your tax return.
BANKRUPTCY
If you have debt cancellation as a result of filing bankruptcy, the debt cancellation is not taxable.
PERSONAL RESIDENCE MORTGAGE RELIEF
Under the Mortgage Forgiveness Debt Relief Act of 2007, enacted Dec. 20, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was less than $2 million. The limit is $1 million for a married person filing a separate return.
The new law applies to debt forgiven in 2007, 2008 or 2009.
The debt must have been used to buy, build or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.
CALIFORNIA LAW
California mortgage forgiveness debt relief law is effective immediately. It is similar to federal law, but with important differences. The California law covers qualified debt forgiven in 2007 and 2008, and it:
Limits the amount of qualified principal residence indebtedness to $800,000 for taxpayers who file as married/registered domestic partners (RDP) filing jointly, single, head of household, or widow/widower, and to $400,000 for taxpayers who file as married/RDP filing separately.
FORMS YOU SHOULD KNOW ABOUT
The creditor will send you form 1099c and will also send this form to the IRS. You should examine the numbers reported on the form and make sure they are correct.
You will need to file form 982 with your federal and state return. If you are claiming insolvency, you will need to attach a statement to your return showing why you are insolvent.
SEEK PROFESSIONAL ASSISTANCE BEFORE YOU COMPLETE THE TRANSACTION
Contact us for more information, for calculations, and for help with completing the forms.