If a homeowner is not able to exclude all debt cancellation based on the Mortgage Forgiveness Debt Relief Act, there may be relief if they can prove t...
If a homeowner is not able to exclude all debt cancellation based on the Mortgage Forgiveness Debt Relief Act, there may be relief if they can prove they were insolvent. You are insolvent when, and to the extent, your liabilities exceed the fair value of your assets. You must determine your liabilities and the fair market value of your assets immediately before the debt cancellation in order to determine whether or not you were insolvent and the amount by which you were insolvent.
For purposes of determining insolvency, your assets must include the value of everything you own (even including any assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your pension plans and the value of any retirement accounts you have). Liabilities include the entire amount of any recourse debts and the amount of any nonrecourse debt that is not in excess of the fair market value of the property that is secured by the debt. You can exclude from your gross income debt canceled when you are insolvent, but only up to the amount by which you are insolvent.
Remember that the insolvency calculation should be done immediately before the debt forgiveness. This can be tough because in many cases the debt forgiveness occurred many months ago. Just consider how difficult it would be to go back six months to a year in the past and try to determine the cash balance in your bank account and the value of your retirement accounts. If fact, the most challenging part is trying to determine the value of your household items and personal belongings, such as jewelry, furniture, tools and equipment, electronics and clothing!
An insolvency calculation should only be done with the assistance of a qualified CPA. It is just too difficult for the average person to do on their own.
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