Still Time to Have Forgiven Mortgage Debt Excluded as Taxable Income

By: Esther Cho 04/02/2012

Homeowners who have had mortgage debt forgiven after a foreclosure, modification, or short sale may be able to exclude the canceled debt from their taxable income if they meet specific criteria.

According to Gil Charney, principal analyst at The Tax Institute at H&R Block, the specific criteria to have forgiven debt excluded are the debt must have been incurred to buy, build or substantially improve the residence, called “acquisition debt, and the property must be the taxpayer’s primary residence.

Also, the exclusion applies only to acquisition debt up to $2 million, or $1 million for married taxpayers filing separately, and cancelled mortgage debt not used to buy, build, or improve a principal residence is not eligible for the exclusion, but may be excludable under a different provision, such as bankruptcy or insolvency, Charney added.

Under the Mortgage Debt Relief Act of 2007, the provision is for debt forgiven between 2007 and 2012.

For those considering a short sale, Octavio Nuiry of Realty Trac warns that waiting to do a short sale after December 31, 2012 may lead to tax penalties that could have been avoided for the homeowner unless the bill gets extended.

According to data from RealtyTrac, since 2007, about 1.8 million U.S. homeowners have sold via pre-foreclosure sale, and most of those were short sales.

In addition, for the year 2011, there were 830,000 completed foreclosures, and from the start of the financial crises in September 2008, there have been about 3.3 million completed foreclosures, according to reports from CoreLogic. Also, 1.4 million homes with a mortgage were placed into foreclosure inventory for the year 2011.

Other types of deductions

Mortgage Interest Deduction – taxpayers are eligible to deduct qualified mortgage interest on their main home and a second home if they itemize deductions on Schedule A

They must be legally liable for repayment of the loan to deduct the loan interest.
For 2011 filings, taxpayers who could not pay at least 20 percent of their down payment may have had to pay for private mortgage insurance (PMI). If the taxpayer qualifies, the PMI may be deductible as mortgage interest.

Real Estate Taxes – homeowners are able to deduct real estate taxes separately from mortgage interest on Schedule A and from property taxes

Nonbusiness Energy Property Credit (expired at the end of 2011) – taxpayers may claim energy-efficiency credits for up to 10 percent of the cost of various home energy-efficiency improvements

Residential Energy Efficient Property Credit – a nonrefundable personal credit is available for property used to produce energy in a personal residence located in the U.S.

The credit is also available for wind energy property and geothermal pumps.
Real estate taxes must be based on the home’s value and assessed at least annually.

(Source: H&R Block)