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Cancelled debt on a home mortgage, part 1: Is it taxable income?

Technically, when some or all of your mortgage debt is cancelled in a foreclosure or short sale, the amount of cancelled debt is supposed to count as income.

But is this really how the IRS expects you to handle things, when you have a debt cancellation on your home mortgage? In this two-part post, we will answer that question.

 In general, there is no tax on the amount of your cancelled debt. But, as with most aspects of the tax code, there are plenty of nuances that can apply to that statement.

The issue of the tax consequences of selling your home when there is a cancellation of some or all of your mortgage debt has been on ongoing one for several years. This goes back to the housing crisis that preceded and accompanied the Great Recession a few years ago.

This crisis left millions of homeowners underwater on their mortgages, owing more than their houses were worth once prices slid. In the economic downtown, many homeowners lost their houses entirely, to foreclosure. Others were forced to do a short sale in which the lender agreed to accept less than the current value of the house and cancelled part of the mortgage debt.

In our September 16 post, we noted that Congress has been unable to commit to ongoing tax relief for principal write-downs. But there is still an exclusion that may apply if you experienced cancellation of mortgage debt in 2014.

For one thing, the tax relief that may be available only applies to a principal residence. If the debt cancellation in question was not for your main home, then the exclusion will not be available to you.

In part two of this post, we will discuss other aspects of eligibility for the exclusion.

Source: IRS.gov, "Top 10 Tax Tips about Home Mortgage Debt Cancellation"

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