Upsolve is a nonprofit that helps you get out of debt with education and free debt relief tools, like our bankruptcy filing tool. Think TurboTax for bankruptcy. Get free education, customer support, and community. Featured in Forbes 4x and funded by institutions like Harvard University so we'll never ask you for a credit card. Explore our free tool
In a NutshellBefore Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 (MFDRA), struggling Americans had to pay additional taxes on debt forgiven due to foreclosure. Because of the strain of these additional taxes, taxpayers usually faced even greater financial troubles than had caused them to face foreclosure in the first place. The MFDRA is a unique law, and only applies to certain forgiven or canceled debt. This article explains how the MFDRA works and what kinds of debt it covers.
Before Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 (MFDRA), struggling Americans had to pay additional taxes on debt forgiven due to foreclosure. Because of the strain of these additional taxes, taxpayers usually faced even greater financial troubles than had caused them to face foreclosure in the first place.
The MFDRA created much-needed tax relief for homeowners who would lose their primary residence that year, and since 2007, Congress has continued to renew these protections. The MFDRA is a unique law, and only applies to certain forgiven or canceled debt. This article explains how the MFDRA works and what kinds of debt it covers.
The Mortgage Forgiveness Debt Relief Act is a federal law that provides tax relief to those who have had mortgage loan debt forgiven or canceled for certain reasons. Specifically, it allows taxpayers to exclude forgiven mortgage debt from their income tax burden.
This is important because before the act was passed, the IRS considered most mortgage debt forgiven through foreclosure and in other situations as taxable income. This designation isn’t unique, as other debt forgiveness - including certain student loan forgiveness options - has the same or similar tax implications.
Under the MFDRA, which has been renewed every year since it was passed in 2007, the IRS will not treat certain forgiven mortgage debt as taxable income. This law also created the Qualified Principal Residence Indebtedness (QPRI) exclusion. With this exclusion, borrowers don’t have to treat certain mortgage debt forgiveness related to their primary residence as income. Because the forgiven debt is excluded in this way, borrowers don’t have to pay taxes on the debt.
The law offers significant relief to homeowners who would otherwise face hefty tax burdens because of their lost real estate. The law was especially important during the housing market crash, which began in 2007 and only got worse in the following years.
The IRS provides useful guidance for mortgage loan forgiveness on its website to help taxpayers apply for this exclusion.
To qualify for exclusion under the MFDRA’s QPRI exclusion provision, the debt forgiveness should be “directly related to a decline in the home’s value or the taxpayer’s financial condition.”
The following situations—all of which usually result in mortgage forgiveness—qualify for exclusion:
Foreclosures are the most common situations that result in a QPRI exclusion. Foreclosure is a proceeding that allows lenders to repossess and sell a foreclosed home for fair market value. Foreclosure becomes an option for lenders when a borrower can’t make their mortgage payments, causing them to default on their home loan.
Of course, most borrowers and lenders want to avoid foreclosure. Borrowers who’d like to stay in their home have alternatives available, including loan modification or stopping or slowing the foreclosure through bankruptcy.
Borrowers going through financial difficulties can sometimes modify their loans to avoid foreclosure. Loan modifications, or loan refinancing, can include changing the length of the loan repayment schedule, lowering the interest rate, or switching from an adjustable interest rate to a fixed interest rate.Debt is sometimes forgiven or canceled as a part of a loan modification agreement.
Short sales occur when a borrower sells their home for less than what is owed on the mortgage. The remaining balance on the mortgage can either be forgiven, or the lender can file a claim in court and get a deficiency judgment against the borrower. The forgiven debt can qualify for the exclusion.
Through a deed in lieu of home foreclosure, borrowers can hand over the deed to their home to their mortgage lender instead of going through foreclosure. Debt is also sometimes forgiven as a part of the agreement with the lender to hand over the deed. The lender will become the owner of the home and will put it up for sale as if it were any other home on the market.
In each of these situations, when the lender doesn’t receive the full amount of the debt owed back when the home is sold, they will write off the balance of the mortgage on their taxes. To do this, the lender will send the borrower and the IRS a Form 1099-C, listing the amount they wrote off.
This written-off amount would have been considered taxable income before the MFDRA was passed. Now, it isn’t considered income, but rather canceled or forgiven mortgage debt subject to the Qualified Principal Residence Indebtedness (QPRI) exclusion.