Let's pick up the thread of a two-part post we began earlier this spring on the taxation of cancelled debt from a home mortgage.
The general rule of course is that a cancelled debt is considered taxable income. But as we explained in our March 5 post, the Great Recession and the real estate crisis that accompanied it put that general rule to the test. With so many people experiencing forclosure or a short sale, Congress responded with legislation that excluded income from cancelled mortgage debt.
In recent years, however, the continuation of that exclusion has become more and more uncertain. In this conclusion of our two-part post, let's look at some of the limitations and requirements for eligibility for the exclusion in 2014.
For one thing, debt cancellation for federal income exclusion purposes goes beyond short sales and foreclosures. It can also apply in other situations.
One of those is a loan modification. You may have gotten behind on your mortgage payments, but then worked with your lender to modify the loan to terms that allowed you to stay in the house.
In this situation, the portion of your mortgage obligation that the lender cancelled as part of the loan modification could be excluded from income. The same is true if you participated in the federal government's HAMP program. (HAMP is the Home Affordable Modification Program.)
What about a refinancing that was initiated by a homeowner looking for a more favorable monthly payment structure? Here, too, an exclusion from taxable income for cancelled debt may be possible. But it can only be taken under certain circumstances. This is the type of question that it is good to discuss in advance with a knowledgeable tax attorney.
You may also be wondering whether the cancelled debt income exclusion relating to real estate is only available on your principal residence. It's true that business or rental property and second homes aren't within the special exclusion passed by Congress. Given the complexity of federal tax law, however, there may be other provisions that can allow you to avoid taxes on cancelled debt income from those sources.
Source: IRS.gov, "Top 10 Tax Tips about Home Mortgage Debt Cancellation"