In this article, we will discuss how to tax canceled mortgage debt. We will talk about the law regarding the exclusion of canceled mortgage debt, when it becomes taxable income, and when it does not. We will also cover how to report canceled debt on your tax return. Finally, we will answer some frequently asked questions on the topic.
The Law on Exclusion of Canceled Mortgage Debt
The law on exclusion of canceled mortgage debt allows individuals to exclude certain canceled debts from their taxable income. This law has been extended several times by Congress, most recently in 2021. Prior to that, individuals could exclude canceled mortgage debt up to $2 million, or $1 million if married and filing separately. With the latest extension, canceled mortgage debt can be excluded up to $750,000, or $375,000 if married and filing separately.
When Does Canceled Mortgage Debt Become Taxable Income?
Canceled mortgage debt is considered taxable income. For example, if you are going through a tough time and your friend gives you $100 to help you, and you promise to pay it back in your next paycheck, but he tells you not to worry about it. Now you have $100 you didn’t have before, even though you didn’t earn it from work. The Internal Revenue Service considers this type of transaction as income to you, and it is subject to tax.
The same principle applies when a bank gives you a sum of money to buy a house by extending a mortgage loan. If the bank goes through bankruptcy and cancels the remaining balance of your loan, the remaining principal balance is considered income because you are no longer obligated to pay it.
Note: Any unpaid interest due is not considered income because it is not taxable.
When Is Canceled Mortgage Debt Not Taxable?
The law on exclusion of canceled mortgage debt specifies certain circumstances under which individuals do not have to pay tax on canceled debts. These exceptions are called “exclusions.” There are three reasons that canceled mortgage debt can be excluded from taxable income:
- The debtor was bankrupt at the time of the bankruptcy proceedings or the sale of the property or loan modification that resulted in the inability to repay the full amount due. Bankruptcy is when your debts exceed the value of your assets.
- The debtor filed for bankruptcy.
- The canceled debts meet the exclusion criteria for certain types of debts, like non-recourse loans.
The home must also have been used as the taxpayer’s primary residence, and this does not include second homes, vacation homes, rental properties, or investment properties.
How to Report Canceled Debt on Your Tax Return
Report canceled debts on line 8 “Other Income” of Schedule 1, which accompanies Form 1040, if you do not meet an exclusion and it is still considered taxable income.
Complete Form 982 if you meet the requirements to exclude some or all of the debt under the law on exclusion of canceled mortgage debt, or the bankruptcy exclusion, or the insolvency exclusion. Identify the exclusion that applies to you by checking the appropriate box under line 1. You may receive what is called Form 1099-C stating these debts, even if you can exclude them, but you may not have to include them in your tax return.
Prepare Form 982 for each exclusion if more than one exclusion applies to you.
Frequently Asked Questions
What if I lost money due to bankruptcy proceedings? Should I report the canceled debt or the loss?
It is treated as
The IRS bankruptcy procedures are just like selling a house. If you have canceled debts, this income is usually taxed. Standard procedures will be followed. If you have a non-recourse loan, it is exempt from this rule, and the canceled debt will not be counted as taxable income.
Do I qualify for the exemption if my vacation home loan debt is canceled?
No, the Mortgage Debt Forgiveness Act only provides tax relief for the cancellation of primary residence debts. If your vacation home loan debt, rental property, or any other type of property that is not your primary residence is canceled, the amount of canceled debt will be counted as taxable income.
How do I report canceled debts to the IRS?
If your mortgage lender cancels or forgives part or all of your debt, you must include the amount in “Other Income” on your Form 1040. You can find this amount on Form 1099-C, which the bank should provide you. If you qualify for the exception under the Mortgage Debt Forgiveness Act, you will need to fill out a separate Form 982, but consult a tax professional if you have any doubts.
Source: https://www.thebalancemoney.com/canceled-mortgage-debts-3192877
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