By Elizabeth Rosen
NEW YORK ( IRS.com) -- The current housing market is full of foreclosed homes and properties that have plummeted in value. In fact, it has been reported that the real estate market has a negative equity gap of about $3.7 trillion, with millions of homeowners underwater on their mortgage loans. The good news is that if you are a struggling homeowner, there may be some relief in sight.
If you owe a debt (such as a mortgage loan) and the lender cancels or forgives part of that debt, the discharged amount (which you no longer owe) may still be taxable according to the IRS. Under the Internal Revenue Code, all types of forgiven debt are still treated as income and subject to taxes.
Mortgage forgiveness through the Mortgage Debt Relief Act of 2007
Enter the 2007 Mortgage Debt Relief Act, which was recently extended to be effective until the end of this year (Dec. 31, 2013). This bill allows taxpayers to exclude income (on their tax returns) from the discharged debt on their principal residence. This can include debt that is reduced by mortgage restructuring as well as debt that is forgiven relating to a foreclosure. If the Mortgage Debt Relief Act had expired, any amount of cancelled debt would be considered taxable income for IRS purposes.
The Mortgage Debt Relief Act applies to the following:
- Homeowners who are granted principal forgiveness on their mortgage loan
- Homeowners who do a short sale on their home
- Homeowners who do a deed-in-lieu of foreclosure on their home
- Homeowners who have lost their home to foreclosure, or are in the process of foreclosure
- Principal forgiveness
- Deeds-in-lieu of foreclosure
- Short sale
In certain cases, the mortgage lender may decide to cancel or forgive part of your debt. This can provide helpful financial relief for struggling homeowners who may no longer have to default on their mortgage loan. With the Mortgage Debt Relief Act, any debt that has been forgiven by your mortgage lender can be excluded from your income and will not be subject to taxation by the IRS. This means that you will not have to pay taxes on debt that you technically no longer owe.