Understanding The Mortgage Forgiveness Debt Relief Act
By Jason Marshall
, last updated September 3, 2011
Ever since the economy crashed in 2008, it has become increasingly important for homeowners in trouble to understand programs like the Mortgage Forgiveness Debt Relief Act. This program is designed to ease the tax burden of homeowners who default on their mortgages. Normally, when a debtor defaults on a loan, the dollar amount being forgiven is considered taxable income. So if someone takes out a loan of $50,000 and pays back $20,000 before having the rest forgiven, then $30,000 would end up being taxable income that he or she would have to file on their tax return.
For many walking away from their mortgage seems like the only solution, but they worry about the impact on their taxes. Suddenly some will have to add hundreds of thousands of dollars to their income, placing those who are already in financial trouble into deeper misery.
The Mortgage Forgiveness Debt Relief Act of 2007 (MFDRA) lifts this burden for people who have to walk away from their mortgages until 2012. This act also helps those who receive loan modifications. The difference in the loan modification is also usually taxable, but the MFDRA applies the same relief as it does to someone that has the bank foreclosing on them. So, for example, if a homeowner renegotiates his or her loan down by, say, $50,000, that amount of money will not be eligible for taxation the way it would have in the past.
There are some qualifications and limits to the MFDRA. This program is only intended for mortgages on one’s primary residence, so second homes or investment properties do not qualify. However, that does not necessarily mean the difference in these cases is automatically taxable. There are many programs that will allow homeowners to avoid hefty tax bills. Debts discharged under bankruptcy, for instance, are not taxable.
It also forgives the taxes on refinanced mortgages, but only up to the amount that would have covered the mortgage directly before refinancing. Anything a homeowner took over the amount of the mortgage to pay off credit cards or put in a new kitchen is not eligible and can be taxed.
There is also a limit on the size of the mortgage that can become tax-free after a write off or loan restructuring. Up to two million dollars is treated as tax free under this act, or one million if married but filing separately. Anything above these limits will be subject to taxation, so be sure your debt doesn’t exceed them before you assume the taxes have been forgiven.
Also, don’t assume that because the income won’t be taxed that you don’t have to declare it on your tax forms in April. You must fill out Form 982 and attach it to your tax form. This will tell the IRS that you are asking to take part in the program and show them how much you are claiming to be exempt from taxes.
The Mortgage Forgiveness Debt Relief Act is in place to aid homeowners who can no longer afford their mortgages and the more people understand what it does, the better prepared they will be to use it.