Q: My husband and I just completed a mortgage loan modification-a process we began in February of this year. We received the agreement and our ARM loan was modified to fixed interest only payments for five years. It changes to principal and interest payments for the remainder of the loan. We were also “forgiven” a little over $92,000 for back amortized interest and three months of missed payments.
We are relieved to finally be over with this modification process. However, it seems that our president and his administration have forgotten to tell the mortgage borrower one thing when it comes to modification and forgiveness: the forgiven amount will be taxed when we file our return for 2010. How does this, in the long run, benefit the borrower, when we are in need of relief due to financial hardship, then we’re hit with a tax burden that is greater than what we earn overall?
We had trouble making our mortgage payment; then we will need to look for some help to pay the IRS and state for $92,000 or more? Shouldn’t there be some tax relief attached to this mortgage modification plan?
Angela, Long Beach, CA
A: Angela, first I’m happy that you were able to get some relief for your burdensome mortgage payments. I know a lot of Americans are crying foul that you even have this option. But studies show that the high foreclosure rates don’t just hurt the defaulting mortgage borrowers, it hurts other homeowners, communities and cities.
However, having said that, you seem a bit ungrateful. The tone of your posting smacks of a sense of entitlement. So, I’m hoping you’ve just been overwhelmed.
As to your tax situation, despite your indignation, Congress and the president (not the current one, the former one) did have forethought to consider the enormous tax bill you might be hit for that $92,000 in forgiven mortgage debt because of your modification.
Under the Mortgage Debt Relief Act of 2007, taxpayers can exclude from their income debt forgiven on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, also qualifies for the relief. Initially, the relief was for debts forgiven in calendar years 2007 through 2009. However, the Emergency Economic Stabilization Act of 2008 extended the debt relief for cancelled mortgage debt until 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if you are married filing separately).
This law was passed specifically for people like you, Angela. Because, typically, if you borrow money from a lender and the debt is later canceled or forgiven, you may have to include the cancelled amount as income on your tax return. When you borrowed the money, you were not required to include the loan proceeds in income because you had an obligation to repay the lender, the Internal Revenue points out. So, if the debt is subsequently forgiven, it’s like you got a windfall. If debt is forgiven, the lender is usually required to report the canceled debt to you and the IRS on Form 1099-C, which stands for Cancellation of Debt.
So Angela, if you want to be sure the $92,000 of your mortgage debt that was forgiven isn’t taxed, you need to fill out IRS Form 982 (pdf), and the form must be attached to your tax return. By the way, it would be attached to your 2009 tax return that is required to be filed in 2010. You can also download the form at IRS.gov, or call 1-800-829-3676.
The IRS says if you are using the form only to report forgiven debt related to your principal residence as the result of foreclosure, you only have to complete lines 1e and 2. If you have stayed in your home and a loan modification resulted in debt forgiveness for your principal residence, complete lines 1e, 2 and 10b.
Click here for the IRS FAQ on the Mortgage Forgiveness Debt Relief Act and Debt Cancellation.
Finally, I hope, going forward, your financial situation improves, so that you will be able to handle your mortgage once it resets in five years.