Under certain circumstances, mortgage lenders in Michigan and around the country could forgive a portion of a home buyer’s debt or choose to reduce the principal balance. When this happens, the forgiven mortgage debt is typically considered taxable income to the borrower and must be reported on their income tax return. However, depending on the borrower’s financial circumstances, taxes on the forgiven debt could be avoided.
Mortgage Forgiveness Debt Relief Act
Initially passed in 2007, MFDRA established guidelines by which taxpayers would not be required to pay taxes on forgiven mortgage debt. While this act was intended to be temporary, it has been extended to cover through tax year 2025.
To be considered nontaxable, the mortgage debt must be acquisition debt. This means the purpose of the mortgage was to acquire the home or make improvements. It could not have been used to consolidate debt or to purchase other property or assets.
Financial qualifications to eliminate taxation on forgiven mortgage debt
Taxpayers who are considered insolvent could avoid paying taxes on canceled debt by completing form 982 on their tax return. This form is a balance sheet in which all debts and assets are listed. If the taxpayer can show they have more debt than liquid and tangible assets, they could eliminate taxes on the forgiven mortgage debt.
Bankruptcy filers may also be able to avoid taxation on forgiven mortgage debt. This will depend on the type of bankruptcy filing and whether the bankruptcy is accepted.
Facing a costly taxable event because of mortgage debt forgiveness can be intimidating. If mishandled, you could end up paying thousands in taxes that you otherwise would not have owed. Luckily, options are available to help you and your family find a new financial beginning.