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Mortgage Forgiveness Debt Relief
The Mortgage Forgiveness Debt Relief Act and Debt Cancellation – 2014 Tax Year
If you owe a debt to someone else and they cancel or forgive that debt, the forgiven amount may be taxable.
The federal Mortgage Debt Relief Act of 2007, provisions of which have been extended to the 2014 tax year, generally allows taxpayers to exclude income from forgiven debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, may qualify for the relief. Similar relief for state taxes is only available on debt discharged before January 1, 2014, but on or after January 1, 2007. Therefore, although California conforms to the 2013 federal exclusion for the discharge of debt from a qualified principal residence, California does not conform to this exclusion for the 2014 tax year.
Does this mean that 2014 mortgage debt forgiveness is taxable for CA purposes?
To answer that question, you must first determine:
- Does the cancellation of debt originate from nonrecourse or recourse debt forgiveness? (See more on these terms below.)Generally speaking, nonrecourse debt forgiveness does not result in a tax liability from Cancellation of Debt Income (CODI). However, a portion of recourse debt forgiven in 2014 may result in CODI, and therefore may be taxable.
- If the debt is recourse, do any exceptions or exclusions apply?There are two common conditions that allow a taxpayer to exclude CODI from their taxable income. The first is when the discharge occurred in a Title 11 bankruptcy. The second is if the taxpayer was insolvent when the discharge occurred. For more information about these and other exclusions, please see IRS Publication 4681. That publication also contains a worksheet to help calculate the extent to which a taxpayer is insolvent immediately before the debt cancellation.
Many different factors can determine the type of debt forgiveness. It may be helpful to consult a tax professional. For additional guidance on the federal treatment of mortgage relief, please see the following three IRS information letters:
Recourse debt: IRS publication 4681, Canceled Debt, Foreclosures, Repossessions, and Abandonments (For Individuals), simply states, “Debt for which you are personally liable is recourse debt. All other debt is nonrecourse debt.” If the lender forgives all or part of the amount of the debt in excess of the fair market value of the property, the cancellation of the excess debt may result in ordinary income. The ordinary income from the cancellation of debt (the excess of the canceled debt over the market value of the property) must be included in your gross income reported on your tax return unless one of the exceptions or exclusions applies. You may also have a taxable gain or loss on the forgiveness to the extent that the fair market value of the property exceeds your basis in the property.
Nonrecourse debt: If you owned property that was subject to a nonrecourse debt in excess of the fair market value of the property, the lender’s foreclosure on the property does not result in ordinary income from the cancellation of debt. The entire amount of the nonrecourse debt is treated as an amount realized on the disposition of the property. You may have a taxable gain or loss on the forgiveness to the extent the outstanding debt exceeds your basis in the property.
Press enter to hide or show content for2014Updated: October 16, 2015California law remains out of conformity with the federal statutory exclusion for certain discharges of qualified principal residence indebtedness for discharges of indebtedness occurring on or after January 1, 2014.
For federal tax purposes, the mortgage debt forgiveness was extended an additional year to provide relief to qualified taxpayers for a discharge of qualified principal resident indebtedness that occurred on or after January 1, 2014, and before January 1, 2015. However, California does not conform to this federal extension. Therefore, any discharge of qualified principal resident indebtedness income from a discharge of qualified principal resident indebtedness that occurred on or after January 1, 2014, and before January 1, 2015, which is excluded for federal purposes may be required to be included in the taxpayer’s California income.
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Press enter to hide or show content for2009 through 2012
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Form 540X – Claiming mortgage forgiveness debt relief for a previously-filed tax return
If you already filed your tax return, file a Form 540X, Amended Individual Income Tax Return, in order to claim debt relief.
If the amount of debt relief for federal purposes is the same as or less than the California limit(s), an adjustment to income is no longer necessary on Schedule CA (540/540NR). On Form 540X, simply enter on line 2e, column B, the amount originally entered on Schedule CA (540/540NR) line 21f, column C.
If the amount of debt relief for federal purposes is more than the California limit(s), complete a new Schedule CA (540/540NR) and revise the amount originally reported on line 21f, column C, attributed to federal mortgage forgiveness debt relief, to the amount in excess of the California limit. Complete Form 540X following the instructions for that form and enter on line 2e, column B the difference from the original Schedule CA (540/540NR), line 21f, column C, less the amount from the revised Schedule CA (540 or 540NR), line 21f, column C.
When filing Form 540X, write “Mortgage Debt Relief” in red across the top of your amended tax return.
Information can be found in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. According to page four of the publication, the following applies to sales and other dispositions (such as foreclosures and repossessions):
According to IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, loan modifications that involve principal balance reductions of a recourse loan generally result in taxable cancellation of indebtedness income. Page four of the publication states the following with regard to discounts and loan modifications: If a lender discounts (reduces) the principal balance of a loan because you pay it off early, or agrees to a loan modification (a “workout”) that includes a reduction in the principal balance of a loan, the amount of the discount or the amount of principal reduction is canceled debt. However, if the debt is nonrecourse and you did not retain the collateral, you do not have cancellation of the debt income. The amount of the canceled debt must be included in income unless it meets one of the exceptions or exclusions.
- IRS.gov search for home foreclosure and debt cancellation.
- IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments
- Federal law – Mortgage Forgiveness Debt Relief Act and Debt Cancellation
- SB 1055 – Legislative Change 08-7
- Press Release April 2010 – California Enacts Mortgage Forgiveness Debt Relief
- Tax News February 2010 – California Code of Civil Procedures and Foreclosure
- Tax News July 2009 – Foreclosure and Short Sales
- Tax News November 2009 – Documents, Second Mortgages, Tax Reporting – How to Handle a Foreclosed Home for Tax Purposes
- Federal law initially applied to discharges occurring from 2007 through 2009 (the Mortgage Forgiveness Debt Relief Act of 2007, Public Law 110-142, December 20, 2007). Federal mortgage forgiveness debt relief was subsequently extended to apply to discharges occurring from 2009 through 2012 (the Emergency Economic Stabilization Act of 2008, Public Law 111-5, October 3, 2008).
- The taxpayer cannot be a C corporation to use this exclusion.