If your home was foreclosed upon or you abandoned it, then there are some tax consequences that you should be aware of. The Mortgage Forgiveness Debt Relief Act of 2007 allows exclusion from income certain debt forgiven or canceled on your principal residence. If the debt was canceled by your lender, you should have received IRS Form 1099-C. For this discussion, “principal residence” is generally the home where you live most of the time.
Usually, a canceled debt is considered income and subject to income tax. However, in the case of your principal residence the cancelled debt is excluded from income if it is qualified debt. In order to be qualified, the debt must have been incurred in acquiring, constructing, or substantially improving your principal residence. It also includes refinance debt if the debt was used to substantially improve your principal residence. Also, the debt must be secured by your principal residence.
The maximum amount of qualified debt that can be excluded is $2 million ($1 million if MFS). Applicable years are from 2007 through 2013. If it turns out the canceled debt is qualified, IRS Form 982 and Schedule D should be filled out. If the cancelled debt is not qualified, then the amount is entered on line 21 of IRS Form 1040.
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