The limit is $1 million for a married person filing a separate return.
Mortgage Restructuring Is Covered Under The Above Exclusion
You may exclude under the above rules debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.
Debt Must Have Been Used to Buy, Build or Substantially Improve Primary Residence
To qualify, the debt must have been used to buy, build or substantially improve your principal residence. Home equity indebtedness is not covered by the new law unless it was used to make improvements to the home.
"Cash out" refinancing, popular during the recent real estate boom, in which the funds were not put back into the home but were instead used to pay off credit card debt, tuition, medical expenses, or make other expenditures, is not covered by the new law. Such debt is fully taxable income unless other exceptions apply, such as bankruptcy or insolvency.
Debt Must Have Been Secured By Residence
To qualify, the debt must have been secured by the primary residence.
Refinanced Debt Proceeds Must Be Used to Substantially Improve Principal Residence To Qualify for the Exclusion
Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.
Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.
File Form 982 with Form 1040
If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.
Second Homes, Rental Property, Business Property, Credit Cards, Car Loans Do Not Qualify
The following debt forgiven do not qualify for this special tax relief provision and are discharge of indebtedness income:
- Mortgages on second homes
- Mortgages on rental property
- Mortgages on business property
- Credit cards debts, or
- Car loans
In some cases, however, other tax relief provisions – including but not limited to insolvency, bankruptcy – may be applicable. For more on these other tax relief provisions please read Cancellation of Debt Income and Exceptions and IRS Form 982.
Form 1099-C Will Report Cancellation of Debt Income
If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.
Be sure to examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.
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