Debt forgiveness does not get one off the hook from The Government
When a borrower talks to a loans lender and promises to pay part of the debt, the debt will sometimes do some debt cancellation. This is only applicable to people who cannot afford their payments but still promise to pay some of the loan back. People love that this safety net is around when they need help.
Then they get the bad news which is, according to the Wall Street Journal, that debt forgiveness is taxable income. The way it works is that since the portion that’s forgiven is technically a bonus toward one’s personal petty cash, that’s income.
The lenders will then give form 1099 C to the borrower, so they can report it on their taxes during the year.
A couple hundred thousand in a mortgage
If a bank agrees to a short sale on your house or a reduction in principle, that has to be reported on a 1099 C for tax purposes, though occasionally you can get exempt from taxes on it. Mortgage forgiveness could be a pretty big chunk of change that you then get taxed on.
In 2007, the government passed a law exempting certain foreclosed-on homeowners from a portion of this debt. The law, the Mortgage Forgiveness Debt Relief Act, also extends, according to CBS, to people who participated or are participating in the Home Affordable Modification Program or HAMP, who received a principle deduction or other modification that would otherwise be matter to the tax.
However, according to the Wall Street Journal, it only applies to home loans to “buy, build or improve” an initial residence. Second-home mortgages are not eligible, so in your yuppie faces.
Will be a headache next year
That law was set to expire last year, but was saved in the “fiscal cliff” negotiations. However, it will lapse before 2014, unless extended. That said, as CBS points out, debt forgiveness for mortgage loans could be claimed over a period of three years or all it once – forgiven homeowners who have not claimed it yet should claim it all this year and reap the benefit of the exemption, if applicable.
Creditcards.com explained that people are getting more debt forgiveness now more than ever. In fact, it is anticipated that the IRS will get 6.5 million 1099 C forms in 2013. In 2003, there were only about 1 million forms filed for debt forgiveness.