History

• The Mortgage Forgiveness Debt Relief Act (MFDRA) went into effect on Dec. 20, 2007, and originally only applied to debt forgiven during the 2007, 2008 and 2009 tax years. While this legislation was originally slated to expire in 2009, an amendment passed in 2008 extended this act to provide relief through the 2012 tax year. The MFDRA originally allowed up to $800,000 in forgiven debt to be excluded from income according to the California Franchise Tax Board.
  
  

Considerations

• Before Congress passed the MFDRA, borrowers had to pay income tax on all mortgage debt forgiven by a bank unless they declared bankruptcy or experienced insolvency. A homeowner already in a 25 percent tax bracket from his regular income would have had to pay $5,000 in tax on $20,000 worth of forgiven debt. Lenders sometimes allow homeowners to conduct a short sale, where the bank reduces the principal on a home loan due to the property having a lower value than the mortgage amount in order to prevent foreclosure. Alternatively, lenders may modify a mortgage in order to reduce the principle on a borrower's mortgage so that the struggling homeowner can make lower monthly payments.
  
  

Eligibility

• In order to qualify for mortgage forgiveness, the borrower must have obtained a first or second mortgage secured by a property in order to build, purchase or substantially improve his primary residence. A taxpayer can exclude up to $1 million in forgiven debt if single or $2 million if married for the 2010, 2011 and 2012 tax years. The MFDRA does not apply to forgiven credit card, second home, student, car or investment property loans.
  
  

Filing

• After the tax year ends, the lender will send both the homeowner and the IRS a Form 1099-C, Cancellation of Debt, which lists the amount of debt forgiven. Taxpayers must file Form 982 with their Form 1040 tax return, which outlines the reason for the discharge of indebtedness and allows the taxpayer to exclude the forgiven debt from his gross income. Taxpayers must claim this tax exemption in the year in which the lender forgave the debt.