Uunder the new Mortgage Forgiveness Debt Relief Act of 2007 (HR3648), enacted on December 20, 2007 and applies to debt forgiven in 2007, 2008, and 2009, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was less than $2 million. The limit is $1 million for a married person filing a separate return.
According to IR-2008-17, borrowers who had some portion of their mortgage debt forgiven in 2007 should receive a Form 1099C from the lender identifying the amount of forgiven debt. Borrowers will have to file Form 982 (specifically lines 1e, 2 and 10b).
The debt must have been used to buy, build or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.
Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision. In some cases, however, other kinds of tax relief, based on insolvency, for example, may be available. The new law grants relief for principal residences sold by their owners or to borrowers who arrange a “workout” with a lender that reduces the outstanding balance of the mortgage.
The new rule also modifies the application of the exclusion when an individual converts a rental or vacation property to his/her principal residence. Under the new rule, effective Jan. 1, 2008, the owner will still have the option of receiving the benefit of the exclusion, but will be required to pay capital gains taxes on the appreciation attributable to the time that the property was used as an investment property. The amount excluded will be a fraction, determined at the time the vacation/rental property is sold. Assuming that the owner has satisfied the two-year residence requirement, the amount of gain that can be excluded will be determined by a fraction. The numerator of the fraction will be the number of years the property was used as a principal residence. The denominator will be the number of years the individual actually owned the property, measured from Jan. 1, 2008.
In addition, the new rule also extends the tax deductibility of Mortgage Insurance through December 31, 2010.