You Walk Away... And Finally the IRS Will Let You Go

In our previous article You Walk Away... But Taxes Can Bring You Back, we wrote about how foreclosure can actually put you in a bigger hole. Basically, the scenario goes like this.

• You go into foreclosure.
• The bank forgives some of your mortgage debt (since you can't pay it).
• The IRS is notified at the end of the year by the bank that they took a capital loss on your mortgage (since they gave money away by forgiving you).
• They tie this "forgiveness of debt" to you and you get hit with a tax bill because this is money that you're basically gaining. It's one less debt on your plate, making your net worth better.
• AND, you wind up owing the IRS mucho money as you become homeless. May I be first to say what the (beep)?

Luckily the government has put in place an act to rectify this loophole.

The Patch

If you got some portion of your mortgage debt forgiven, the mortgage company will send you a form 1099-C. If you receive this form, you must fill out a Form 982 (which is now available for electronic filing) and include it with your 2007 return. The same goes for the 2008 and 2009 filing years. This will prevent you from owing on that debt.

The Restrictions

• The balance on your loan must be under $2 million, or $1 million if you file married jointly
• Debt forgiven is not for a second home, timeshare, or rental property.
• Debt forgiven is not for a credit card or car loan.

Additionally, debt from refinancing or money used to do home improvements may be eligible, but only up to the old mortgage principal.

Additional Resources

Foreclosure Prevention Act of 2008 by Linda Beale