- Because of the millions of people losing their homes to foreclosure or having their mortgages modified so they could stay in their homes during the 2007-2010 recession, Congress passed the Mortgage Debt Relief Act of 2007. This act allowed most taxpayers to exclude forgiven mortgage debt from their income if the mortgage was used to buy, build or substantially improve the taxpayer's primary residence.
- The main reason that homeowners are not able to claim an exclusion for mortgage debt is if the mortgage was used for a purpose not related to the home. Homeowners who got a cash-out refinance or a home equity loan often used this money, which was secured by the home, to pay off other debts or make purchases unrelated to the home. The amount of money used for these purposes and subsequently forgiven through a foreclosure or loan modification is likely to be taxable income unless the homeowner can claim a different exclusion.
- The tax-free mortgage debt forgiveness is only good for the first $2 million of mortgage debt. If your mortgage was larger than that, part of the forgiven debt will still be taxable. To calculate how much is taxable, subtract $2 million from the amount of your mortgage at the time the debt was forgiven. Then subtract the result from the amount of forgiven debt. For example, if you had a mortgage for $2,200,000, that is $200,000 above the limit for the debt forgiveness legislation. If $700,000 was forgiven, subtract the $200,000 that was above the limit and claim an exclusion for the remaining $500,000. The $200,000 is taxable unless it falls under another exclusion.
- When you receive mortgage forgiveness, you must note this when filing your tax return, even if you do not have to pay taxes on it. Fill out lines 1e and 2 on Internal Revenue Service Form 982 to state the amount of debt that was forgiven. If you had a mortgage modification that included forgiving part of the debt but you still own the home, fill out line 10b as well.