Understanding the Debt Relief Act

Understanding the Debt Relief Act

Many people don’t understand the Debt Relief Act, but this information can be quite powerful when helping you understand your tax liability. Under normal circumstances, when you borrow money from a commercial lender and they later cancel or forgive your debt, you have to include the canceled amount as income for tax purposes. The amount of loan proceeds that you receive back must be reported as income because you’re no longer under obligation to repay the lender. Your lender will likely file Form 1099-C, which indicates a cancellation of debt and reports the amount to the IRS.

But there’s a way for some borrowers to usurp this particular tax liability. The Mortgage Relief Act of 2007 usually allows taxpayers to exclude income from the discharge of debt on their principal residence if their debt was reduced because of mortgage restructuring, they faced a foreclosure, or they qualify for the relief. The Debt Relief Act applies to debt forgiven from 2007 through 2012. Under this program, up to $2 million in debt is eligible for exclusion for married couples, or $1 million if married and filing separately.

Debt cancellation is not always taxable though, so it’s best to sit down with a financial professional to ensure you quality for the Debt Relief Program. The most common situations where debt income is not taxable include indebtedness on a qualified principal residence, bankruptcy, insolvency, certain farm debts, and non-recourse loans. Even if your forgiven debt is excluded from income, you still need to report it on Form 982 and attach that to your tax return. In order to determine how much debt was forgiven, your lender should send you a Form 1099-C, and the amount will be listed in box 2.

Also, if your forgiven debt doesn’t qualify under this particular provision, it may qualify under the insolvency exclusion. You are insolvent when your total liabilities exceed your total assets. The Debt Relief Act does not apply to losses on the sale or foreclosure of personal property.

For more information on the Debt Relief Act, click here.