If a lender cancels part or all of a debt, a taxpayer must generally consider this as income. However, the law allows an exclusion that may apply to homeowners who had their mortgage debt canceled in 2017. Here are seven things you should know about debt cancellation:
1. Main Home. If the canceled debt was a loan on a taxpayer’s main home, they may be able to exclude the canceled amount from their income. They must have used the loan to buy, build or substantially improve their main home to qualify. Their main home must also secure the mortgage.
2. Loan Modification. If a taxpayer’s lender canceled or reduced part of their mortgage balance through a loan modification or “workout,” the taxpayer may be able to exclude that amount from their income. They may also be able to exclude debt discharged as part of the Home Affordable Modification Program (HAMP). The exclusion may also apply to the amount of debt canceled in a foreclosure.
3. Refinanced Mortgage. The exclusion may apply to amounts canceled on a refinanced mortgage. This applies only if the taxpayer used proceeds from the refinancing to buy, build or substantially improve their main home and only up to the amount of the old mortgage principal just before refinancing. Amounts used for other purposes do not qualify.
4. Other Cancelled Debt. Other types of canceled debt such as second homes, rental and business property, credit card debt or car loans do not qualify for this special exclusion. On the other hand, there are other rules that may allow those types of canceled debts to be nontaxable.
5. Form 1099-C. If a lender reduced or canceled at least $600 of a taxpayer’s debt, the taxpayer should have received Form 1099-C, Cancellation of Debt, by January 31, 2018. This form shows the amount of canceled debt and other information.
6. Form 982. If a taxpayer qualifies, report the excluded debt on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. They should file the form with their income tax return.
7. Exclusion Extended. The law that authorized the exclusion of cancelled debt from income was extended through December 31, 2017.
Don’t hesitate to contact the office if you have any questions about canceled debt.