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Cancellation of Indebtedness - Issue Summary

Tools still available for mortgage debt relief till 2012 !

A lender will, on occasion, forgive some portion of a borrower's debt. The general tax rule that applies to any debt forgiveness is that the amount forgiven is treated as taxable income to the borrower. Some exceptions to this rule are available, but, until recently, when a lender forgave some portion of a mortgage debt (such as in so-called "short sales," foreclosures and "workouts"), the borrower was required to pay tax on the debt forgiven. A new law enacted in December 2007 will provide relief to troubled borrowers when some portion of mortgage debt is forgiven. That relief expires on December 31, 2012.

Relief from the cancellation of indebtedness rules should greatly facilitate the sale of homes in areas where home prices have declined or where foreclosures have occurred. In addition, providing tax relief would correct the prior-law unfair circumstance in which the only individuals who paid tax on the sale of a residence are fortunate sellers who have gains of more than $250,000/$500,000, and unfortunate sellers who have seen the value of their property decline.

NAR supports an exclusion from taxation of the phantom income generated when all or a portion of a mortgage is forgiven. There should be no taxable event when a lender forgives some portion of a debt in a short sale, foreclosure, bank workout or similar situation. Such relief would be limited to principal residences only. It would not be available for home equity debt.