Financial Lending Notes
April 27, 2009

Tax Consequences of Mortgage Debt Forgiveness

As a result of the mortgage meltdown and the ongoing rise in foreclosures, many individuals today are dealing with mortgage restructuring and mortgage debt forgiveness.

The tax treatment of income that results from what’s known as a Discharge of Indebtedness (DOI), however, can be confusing. The Internal Revenue Code (Sec. 61(a)(12)) subjects any gross income that results from a DOI to taxation.

The good news is that the federal government has stepped in to help the thousands of families getting hit with huge tax bills after losing their house due to foreclosure. The Mortgage Forgiveness Debt Relief Act of 2007 allows taxpayers to exclude income from the discharge of debt on their principal residence. There is no dollar limit if the principal balance of the loan was less than $2 million (or $1 million if married filing separately) at the time the loan was forgiven. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for this relief.

This provision originally applied to debt forgiven in 2007, 2008 and 2009, but was extended through 2012 by the Emergency Economic Stabilization Act of 2008. However, it is important to note that this change only applies to homes used as a principal residence. Debt forgiven on second homes, rental property or business property does not qualify for this tax-relief provision.

Individuals should receive Form 1099-C Cancellation of Debt from their lender showing the amount of debt forgiven or cancelled. The IRS urges borrowers to check this form carefully, paying particular attention to the amount of debt forgiven (Box 2) and the value listed for their home (Box 7).

 

Compliments of:

Porter Keadle Moore, LLP (PKM) is a full service accounting firm based in Atlanta, Georgia. PKM offers audit, tax and systems services to clients throughout the country. The firm focuses its efforts on companies registered with the Securities and Exchange Commission (SEC), community banks, the insurance industry, technology and life sciences companies and the real estate/construction industry.
 

To discuss this article contact Pat Tuley, CPA with Porter Keadle Moore, LLP at ptuley@pkm.com.

Pat has over 23 years of experience in public accounting. He has worked with clients ranging from individuals to international Fortune 50 companies in a variety of tax consulting and compliance areas. He is most active in the real estate and banking industries, serving numerous clients across the Southeast. Pat has led PKM’s tax practice since 2003. Prior to joining PKM he was a partner with KPMG, where he spent 17 years of his professional career.

 
Regulators Clarify Banks’ Roles and Responsibilities

Late last year, federal regulatory agencies issued a joint statement emphasizing the “prudent role that bank lending practices play in promoting the nation’s economic welfare.” The agencies encouraged banks to work together with regulators to ensure that the needs of creditworthy borrowers are met, specifically by:
  • Providing credit in a manner consistent with prudent lending practices, and continuing to ensure that they consider new lending opportunities on the basis of realistic asset valuations and a balanced assessment of borrowers’ repayment capacities.
  • Maintaining a strong capital position by ensuring the adequacy of their capital base and focusing on effective and efficient capital planning and longer-term capital maintenance.
  • Engaging in appropriate loss mitigation strategies and foreclosure prevention by working with existing mortgage borrowers to avoid preventable foreclosures, as well as mitigate other potential mortgage-related losses.
  • Reassessing the incentive implications of their compensation policies to ensure that they are aligned with the long-term prudential interests of the institution.
 

Tim provides accounting and auditing services to financial institutions as well as clients in the construction, service, technology/life sciences and manufacturing/distribution industries. He routinely works with companies registered with the Securities and Exchange Commission; privately-owned companies and S Corporations. He has experience with Initial Public Offerings (IPOs), Mergers and Acquisitions, Sarbanes-Oxley compliance and internal control consulting. You can contact Tim at tmessman@pkm.com.