The President signed into law a new measure that would eliminate the tax burden on forgiven mortgage debt (read more). With the rise in short sales and foreclosures across the country, many homeowners were responsible to pay tax on any and all of the mortgage balance that wasn’t paid or forgiven. A lot of the time, the homeowner didn’t know about this until tax time.

For those of you not familiar with this, let me explain.

If your loan balance is $175,000 and you either negotiate a short sale or end up in foreclosure, the difference between what you owe and what the bank receives is a deficiency. Let’s say the bank only receives $150,000 from the sale or auction, your deficiency would be $175,000 – $150,000 = $25,000. The bank could send you a deficiency note where you would be responsible for repaying the $25,000 or they could forgive the deficiency and not make you repay it.

If they forgive the $25,000 they would report to the IRS that they did so and then send you a 1099-C at the end of the year.

Cancellation of debt may not always be taxable. There are some exceptions like bankruptcy, insolvency, certain farm debts and non-recourse loans. PLEASE consult with your CPA or professional tax advisor regarding your situation. For more information, check out this IRS publication.

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