12.3.3 Principal Residence Indebtedness
12.3.3 Principal Residence Indebtedness aetrahan Fri, 02/03/2023 - 14:15The Mortgage Forgiveness Debt Relief Act of 2007 allows the exclusion of debt cancellation income from mortgage restructuring or mortgage foreclosure on a taxpayer’s home for debts forgiven for the years, 2007-2013.1 This Act has been extended numerous times and now covers the years 2014 through 2026. The exclusion is limited to $2 million ($1 million if filing status is married filing separately). The Act applies only to forgiveness or cancellation of debt to buy, build, or substantially improve a “principal residence” or to refinance debt incurred for these purposes. Refinanced home mortgage debt may include acquisition indebtedness and home equity debt. The home equity debt is not eligible for the qualified principal residence exclusion.2 Lenders’ principal reductions pursuant to the National Mortgage Settlement may qualify for exclusion from income under I.R.C. § 108(a)(1)(E) if the debt was acquisition debt and the cancellation occurred before January 1, 2014 or any extended date of the Act.
“Principal residence” in § 108 has the same meaning as in “principal residence” in I.R.C. § 121.3 A § 108(a)(1)(E) exclusion does not apply in a bankruptcy discharge.4 The § 108(a)(1)(B) insolvency exclusion does not apply to discharged debt to which § 108(a)(1)(E) applies unless the taxpayer elects a §108(1)(B) insolvency exception.5 A Form 982 must be filed with the taxpayer’s return to claim the § 108(a)(1)(E) exclusion from income.
Income excluded under I.R.C. §§ 108(a)(1)(A)–(C) must be applied to reduce the debtor’s “tax attributes.” As a practical matter, this reduction of basis in an indigent taxpayer’s assets will have little or no effect on the ultimate tax liability since the basis will likely be small. The basis in an asset is the price originally paid for it, along with certain maintenance and repair costs.