Debt Forgiveness: Tax Considerations
Friday, March 18, 2011 at 10:40AM March 16, 2011
By: Stephen J. Nash
Nash Law Firm, PLLC
nash@nash-law.com
With millions of Americans facing foreclosures and other debt related problems, their focus is primarily on how they can satisfy all of their obligations so they can begin to recover. In most cases, this can only happen if there is debt forgiveness.
In the case of the homeowner who is underwater, the homeowners options often are reduced to a short sale or a foreclosure. In either case, the lender will not be made whole and, but if debt is forgiven, the homeowner can start to recover.
If there is debt that is not secured, the creditors option is to sue the debtor and if a settlement is reached to avoid such a lawsuit, there is often debt forgivness as a part of that deal.
Lost in the shuffle, is the tax considerations of such debt forgiveness deals. First off, everyone should consult with a tax professional to look at their specific situation. Generally, when debt is forgiven, the amount forgiven is considered ordinary income to the debtor. It is not different than if someone had given you the money to pay off the debt.
There are exceptions ot the general rule. The key one in effecting todays real estate owners is a temporary exception that was passed by Congress to to help deal with todays problems. If the debt cancellation involves your principal residence and if the money you borrowed was used to buy, build or substantially improve that home, you will not have to pay any income tax on the debt that was forgiven by your lender. This temporary law extends through 2012.
There are other excemptions and applying the above referenced rule can be tricky so it is always best to consult with a knowledgeable tax person when considering your debt options. While debt forgivenss may be the first step towards your recovery, if you don't consider the tax consequences, you may be further away from recovery than you thought.
The following is a link to a great article found in Inman News: