How the Mortgage Debt Relief Act Benefits Homeowners

The Mortgage Debt Relief Act was put into place in 2007 to help relieve the tax burden of debt for some borrowers. In reality, very few homeowners will benefit from the provisions of the Mortgage Debt Relief Act. The Act applies only to those homeowners who have had a portion of their debt canceled or forgiven. These individuals may have the chance to avoid being taxed on that debt depending on their exact circumstances.

Taxes on Debt Relief

It can be confusing to understand why you would be taxed on debt. You need to think of the debt you incurred to purchase your home as a source of income. With that loan, you purchased a home, and you gained equity in that home. You were never taxed on that sum because, in most cases, you will repay that sum back to the lender. In fact, you will pay more than that sum back, and your interest on your mortgage is also tax deductible. If you are exempt from repaying the sum, though, because the debt was canceled or forgiven, then it was actual income you received and kept. In this case, it should be counted as income on your next tax filing. 

Exemptions from Tax

There are some consistent exemptions from paying taxes on a canceled debt. Those exemptions include: 

  • Debts discharged through a legal bankruptcy proceeding.
  • Debts forgiven when the you are insolvent, meaning your total assets do not cover your total debts. It is rare to be in a state of insolvency and not file for bankruptcy.
  • Certain debts incurred when your principal income came from earnings on a farm may not be taxable if the debt is canceled or relieved.
  • If you took a non-recourse loan, your lender cannot continue to collect on your debt. Instead, the lender can only foreclose on the property and liquidate it to recover. In this case, the remaining debt would be considered "forgiven," but it may not be taxable in all cases.
  • Finally, the Mortgage Debt Relief Act provides for a tax exemption for qualified principal residence indebtedness, meaning any debt forgiven on your primary place of residence. 

Mortgage Debt Relief Act

Essentially, the Act provided for one final exemption from taxes owed on forgiven debt. If the debt is incurred in the process of buying, building or significantly improving your principal place of residence, you do not have to pay taxes on the forgiven sum. You should note: it is possible a portion of the tax may still be applied. However, in most cases, the entire sum forgiven will not be taxed. Forgiven debt that falls into this exemption typically only comes into play when a mortgage is refinanced at a lower assessed value or a home is foreclosed upon. The exemption only applies between 2007 and 2012. There is a $2 million limit on the sum that can be excused; this sum is per household, and married people filing separately have a $1 million limit each. If you think you qualify for this relief, you will need to fill out No. Form 982.