‘Mortgage Cancellation of Debt’ Category

Cancellation of Debt Income Exclusions

The general rule when it comes to cancellation of debt is that it is a taxable event. But there are some exceptions that you should be aware of. The m...

 

The general rule when it comes to cancellation of debt is that it is a taxable event. But there are some exceptions that you should be aware of. The most common situations when cancellation of debt income is not taxable involve bankruptcy, the Mortgage Forgiveness Debt Relief Act, insolvency, and certain farm and business indebtedness.

Discharges in bankruptcy are generally excluded.  If you think this exclusion applies to your situation, make sure to discuss it with your attorney and your CPA.  I find that all too often people think this applies to them, but the cancellation of debt either occurred before or after the bankruptcy date.

Another exclusion is available under the Mortgage Forgiveness Debt Relief Act.  This Act came into place in 2007 and allows certain exclusions through 2012.  The Act applies to qualified indebtedness (normally purchase money and/or original acquisition debt) on a principal residence.  Many homeowners will qualify under the Act, but be careful if you did a cash-out refinance or took out a second mortgage.  This is where people can often run into trouble.

If the cancellation of debt relates to your primary residence and you don’t qualify under the Act, you may very well qualify under the insolvency exclusion.  The insolvency exclusion is very complex and I will dedicate an entire blog post just for this issue.  Let’s just say that if you don’t have many assets and you have substantial liabilities you may be able to exclude certain cancelation of debt from income on your tax return.

You can exclude certain farm cancelation of debt from income.  Generally, if the debt was incurred directly in the operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancellation of debt is generally not considered taxable income.

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