Is Forgiven Mortgage Debt Taxable as Income?

Income tax preparationBank of America and the government’s foreclosure rescue program are initiating mortgage writedowns. A both public and private effort to rescue ‘underwater’ borrowers is picking up steam.
But is forgiven mortgage debt taxable as income? For the most part, it is not. And that is good to know for some as April 15 approaches.
The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced from mortgage restructuring qualifies for this relief. So does mortgage debt forgiven through foreclosure.
The relief is in effect through 2012. Up to $2 million of forgiven debt is eligible for this exclusion – $1 million if married filing separately.  Prior to the law, most mortgage debt forgiveness above a home’s fair market value was usually treated as taxable income.
“The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition,” the IRS states.
Nonetheless, homeowners who will have or have had mortgage principals reduced and remain in their homes, or those whose debt was erased above a short sale’s price, should consult a tax professional or research filing requirements with the IRS.
In most cases, eligible homeowners only need to fill out a few lines on Form 982, the IRS said.
In the case of the government’s new short sale, or deed-in-lieu, foreclosure prevention program, a payout of up to $3,000 to help pay moving expenses may have to be reported as income.
”We suggest that you contact the IRS or your tax preparer to determine if you may have any tax liability,” reads a typical letter sent to potential participants in the government’s new Home Affordable Foreclosure Alternatives program

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