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I short sold my home this year and was told by my Realtor that the government forgives taxes which would normally be owed by selling a property for a loss. I had heard this before and assumed it would apply to both our first and second mortgage. Of course our Realtor knew we had two mortgages.

After the sale, I read online that this law, The Mortgage Forgiveness Debt Relief Act, does not apply to second mortgages. Is this true? And if so, assuming the forgiveness of our second mortgage totaled $80,000, is this going to be treated as ordinary income on our taxes next year? If this puts us in say, a 25% tax bracket, does this mean we'll be hit with a $20,000 tax bill?

Is there anything we can do now to mitigate this situation?

Clarification: our second mortgage was used to buy the house and taken out at the same time as the first to finance 100% of the purchase price.

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  • That is bad situation and I am sorry. If the deal is already finished on your house, you really should see a tax person as littleadv suggests to know what you need to do come next April. See a CPA if you can afford it.
    – MrChrister
    Commented Sep 7, 2012 at 18:14
  • @MrChrister tax advice can only be given by a CPA, EA or an attorney. All the rest are opinions.
    – littleadv
    Commented Sep 7, 2012 at 18:15
  • @MrChrister thanks, appreciate that. Our tax guy's on vacation so I thought I would start here.
    – dave4351
    Commented Sep 7, 2012 at 20:14

2 Answers 2

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You shouldn't have asked a realtor for tax advice. There are tax professionals for that. at least you didn't ask your realtor what prescription drugs to take (or so I hope).

Bottom line is that Mortgage Debt Relief Act only talks about the loans that were taken to purchase/significantly improve the primary residence sold at a loss, or loans taken to refinance the above.

If it your mortgages were used to purchase the house, then it should fall under the definitions of the act. But you should have a tax professional research both the loans and the act and see if and how it applies to your situation.

If your second loan was not taken for these purposes it is likely not to be qualified for forgiveness. So yes, $20K tax bill.

I would suggest talking to a tax professional and getting a professional advice on both the interpretation of the law and its application on your situation, and how to deal with it now.

This response is not a tax advice, and wasn't written to be used and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer.

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  • Just to clarify, the second mortgage was used to purchase the property. We bought it 0% down, with two mortgages (80% and 20%). Does that change anything?
    – dave4351
    Commented Sep 7, 2012 at 20:11
  • if it was used to purchase then it should fall under the definitions of the act. But you should have a tax professional research both the loans and the act and see if and how it applies to your situation.
    – littleadv
    Commented Sep 7, 2012 at 20:12
  • OK, thanks, will do. If you'd like to revise your answer to clarify this point for future readers, please do. Then I will accept your answer and get on the phone with the tax guy.
    – dave4351
    Commented Sep 7, 2012 at 20:17
  • added to the answer.
    – littleadv
    Commented Sep 7, 2012 at 20:20
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The Mortgage Forgiveness Debt Relief Act covers debt that is for the original purchase, building or major improvement of a principal residence. Cancellation of second mortgages and refinances taken out in excess of the amount owed at the time of application do not qualify for tax-exempt status in most cases. Only the amount of the debt forgiven which homeowners used specifically for home improvements is tax-exempt.

Using Form 1099-C, the lender reports the amount of debt canceled as well as the value of the property at the time of the cancellation of the debt. Borrowers who claim that second mortgages or lines of credit are exempt need to provide receipts that prove the money went to home repairs and improvements.

Source: http://homeguides.sfgate.com/mortgage-forgiveness-debt-relief-act-7269.html

It looks like as long as you can prove that the second mortgage was used for the purchase of the home, it may qualify for the debt forgiveness act - but you should consult a CPA to make sure.

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