WHAT HAPPENS IF I HAVE MORTGAGE DEBT FORGIVEN

Thanks for all the information you send out. I have a question. A relative of mine had a portion of their mortgage forgiven. I told him that he would have to pay tax on the forgiveness. He said I was wrong. Who is right?

Eagle

Depends. If a mortgage debt is partly or entirely forgiven during tax years 2007 – 2012, you may be able to claim special tax relief and exclude the debt forgiveness income. You are correct in that normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

Here is the catch. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion. However, proceeds of refinanced debt used for other purposes (for example, to pay off credit card debt) do not qualify for the exclusion.

Also, debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision.