Tuesday, March 17, 2015

Debt Forgiveness Can Bite Come Tax Time

By Cornelius Nunev

Debt forgiveness is a fantastic thing. A lender that decides to forgive some part of one's loans is great, but it comes with a caveat. The hitch is that the forgiven debt is handled and taxed as income by the IRS, which will hurt come tax season.

Debt forgiveness does not get one free from The Government

When a loans lender chooses to forgive debt, it is called debt relief or debt cancellation. People love it when this occurs. It typically is forgiven as long as the person pays part of the debt.

Then they get the not so good news which is, according to the Wall Street Journal, that debt forgiveness is taxable income. The way it works is that since the portion that's forgiven is technically a bonus toward one's personal petty cash, that's income.

Borrowers have to report the cash on their tax forms with the form 1099 C, which forgiving lenders must give out.

Think about your home loan

If a bank agrees to a short sale on your house or a reduction in principle, that has to be reported on a 1099 C for tax purposes, though occasionally you can get exempt from taxes on it. Mortgage forgiveness can be a pretty big chunk of change that you then get taxed on.

Any person in the Home Affordable Modification Program, or HAMP, could avoid paying taxes on the reduction or modification of their home loan, according to a 2007 law called the Mortgage Forgiveness Debt Relief Act. It also helped people who were foreclosed on from dealing with additional taxes.

However, according to the Wall Street Journal, it only applies to mortgages to "buy, build or improve" a primary residence. Second-home home loans are not eligible, so in your yuppie faces.

Last year expiration

Homeowners who are dealing with debt forgiveness for home loans may have an easier time if claiming the amount over three years rather than all at once, which is one of the choices. For those who have not claimed it yet, you need to do so now, so you can get the tax exemption. It will only be available until 2014 now that the fiscal cliff negotiations have been finalized, according to CBS. It was going to expire last year, but now it is continued.

Creditcards.com explained that people are getting more debt forgiveness now more than ever. In fact, it is expected that the Internal Revenue Service will get 6.5 million 1099 C forms in 2013. In 2003, there were only about 1 million forms filed for debt forgiveness.

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