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Friday, December 7, 2012

Mortgage Loan Forgiveness & Taxes – IRS Insolvency Exclusion

Mortgage Loan Forgiveness & Taxes – IRS Insolvency Exclusion


As an attorney who represents borrowers and homeowners in mortgage disputes, mortgage relief matters, and foreclosure cases  in multiple states, I am frequently asked about possible tax consequences if a borrower does not have to pay the entire loan back. This can occur is various scenarios; some of the more common ones involve partial forgiveness of a mortgage loan as part of a modification, forgiveness of the outstanding balance as a result of a deed in lieu or negotiated satisfaction of a mortgage loan, or even in instances in which a foreclosure occurs and the foreclosure sale does not bring enough proceeds to cover the entire outstanding loan balance.

I am not a tax attorney, and I am not a CPA, and I always tell my clients who are faced with this issue to seek advice from one or both of those types of professionals (such as our Angel Oliver or Kelly Brown).  However, I can provide information regarding the “insolvency exclusion” as outlined by the IRS. This exclusion will help most individuals reduce or completely eliminate any federal tax liability in relation to a canceled debt.

Let’s take a scenario in which John Doe’s assets (the value of everything John owns) total $100,000 while John Doe’s liabilities (all of his qualifying debts – including the entire amount of the debt at issue) - total $200,000.[1]  This means that John Doe is insolvent by $100,000.

Let’s say that John’s mortgage loan lender is prepared to forgive $75,000 of mortgage loan debt.  Because John is more than $75,000 insolvent, he is probably able to exclude the entire $75,000 of debt forgiveness, and generally would not be required to pay federal taxes on it under this exclusion. However, if the amount of debt to be forgiven was $125,000, then this exclusion, if it applied would only allow him to exclude $100,000 of the $125,000. Of course, the outstanding $25,000 which is not excluded may be impacted by other sections of the tax code, which is only one reason that it would be wise of John to seek consultation with a tax attorney or, more likely, a qualified CPA.

I want to emphasize two important points.  Number one, this exclusion applies to mortgage loan debt and other types of debt.  Number two, the exclusion should be calculated by using the assets versus liabilities immediately before the debt cancellation.

Of course, as referenced above, there are other laws and parts of the tax code which can have relevance to mortgage loan debt and related tax matters, such as the Mortgage Forgiveness Debt Relief Act of 2007 , which is discussed by this author -  IRS, Taxes – Mortgage Forgiveness Debt Relief Act expiring! Key Facts 1 – 5 and IRS, Taxes – Mortgage Forgiveness Debt Relief Act Expiring! Key Facts 6 – 10.




[1] Please see IRS Publication 4681, in order to review a more full explanation of what liabilities are counted. Also see that publication for specific examples, additional details, and how the relevant tax forms should be completed.

McGrath & Spielberger, PLLC provides assistance to those involved in mortgage disputes, including borrowers in need of mortgage relief services such as mortgage loan modification, foreclosure negotiation,  and deed-in-lieu or other negotiated settlement resolutions.