Q: When we started to go into foreclosure last year, we negotiated with the bank, and they set a meeting to sign all the papers needed to give the house back to the bank for forgiveness of the mortgage. The house was worth much less than the mortgage at the time the bank took it back, but we did not have any debt to the bank after we signed it over. Do we need to report the forgiven portion of the debt as income?
A: The good news is, there is probably no taxable debt relief to report. The Mortgage Forgiveness Debt Relief Act of 2007 specifically allows taxpayers to avoid claiming mortgage debt relief as debt forgiveness income, whether the debt forgiveness was from a walk-away as you describe, or forgiveness of the debt after foreclosure and re-sale, or mortgage restructuring that forgives part of the mortgage debt.
The bad news is, the debt relief was too new to make it into most tax software packages for 2008, so to claim this debt relief, you will need to fill out Form 982 and attach it to the back of your tax return.
IRS publication 4681 has detailed examples of the type of forgiven debt that is (and is not) eligible for relief.
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