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How to Handle Tax Reporting of Mortgage and Real Estate Debt Relief

Dealing with debt relief on your mortgage or real estate can get confusing really fast, especially when it comes to reporting everything properly on your taxes. But have no fear – this article will walk you through the key things you need to know to make sure you stay compliant with the IRS.

Let’s start with the basics. The IRS sees any debt that is cancelled or forgiven as taxable income. This means if your lender agrees to reduce the principal balance on your mortgage, waive fees you owe, or forgive a portion of your overall debt, they likely have to report that amount to the IRS and send you a Form 1099-C detailing the amount cancelled.

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I know what you’re thinking – getting debt relief helps me out, only to then owe taxes on it? What gives? Believe me, I feel your frustration. But them’s the breaks when it comes to the IRS code. Any amount of debt relief you receive over $600 in a calendar year gets reported.

The good news is there are some exceptions to this rule:

  • Debt cancelled in bankruptcy – if your debt is discharged as part of a bankruptcy filing, it does not count as taxable income. Phew!
  • Principal residence exclusion – if the cancelled debt is on your primary home, you can exclude up to $2 million in debt relief ($1 million if married filing separately) from being taxed. This can really save your hide.
  • Insolvency exclusion – If you can prove your total debts exceed your total assets and resources, you can exclude debt relief up to the amount you are insolvent.

There are a few other more obscure exclusions too, like if the debt was qualified farm debt or qualified real property business debt. Check out IRS Publication 4681 for full details.

Tracking Your Debt Relief Amounts

So the first key is understanding if you even have any taxable debt relief or not based on those exclusions. If you do receive a 1099-C from your lender, don’t panic! Here are some steps to take:

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  • Review the 1099-C form closely – are the debt amounts excluded or exempt for any reason? Is your lender just sending it for their own reporting without realizing an exclusion applies to you? Mistakes happen, so double check.
  • Gather documentation on any exclusions or insolvency calculations. You’ll need these to back up your tax return.
  • If an exclusion clearly doesn’t apply, then you’ll likely recognize that debt relief as taxable income. Calculate what tax you might owe on that income amount. Set aside money to pay it or make estimated tax payments.

I know, I know, it stinks to owe even more money to the IRS. But unfortunately them’s the breaks. Maybe call your Congressional rep to complain about how complicated tax law is these days!

Reporting on Your Tax Return

Assuming you do end up with taxable debt relief, here are some pointers on handling it right:

  • Report the 1099-C amount on Line 21 of your Form 1040. This flows through to help calculate your total taxable income level.
  • File Form 982 to claim any exclusions and provide all those back-up documents. This adjusts your income back down.
  • If your exclusion documentation doesn’t clearly prove to the IRS that an exclusion applies, expect to get notification from them with proposed adjustments. Be ready to appeal.
  • Keep excellent records for at least 3 years showing how you calculated exclusions as well as documenting the insolvency. You need to be able to back up your facts if challenged down the road.

Getting Help

Trying to navigate Form 982 and complex exclusion calculations on your own can be super frustrating (not to mention getting IRS notices if you miss something!). Lots of folks find getting some expert help invaluable here. Consider reaching out to a tax professional or lawyer to review your situation and ensure you claim everything you legally can.

Debt relief and taxes might seem incredibly convoluted. And they are! But take it step-by-step, know what options are available to potentially reduce your tax burden, and don’t be afraid to have an expert set of eyes review. The IRS code is insanely complex, so if you can reduce what you owe while following the rules, that’s a win in my book.

Here’s to less debt and less taxes! We got this.

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