What Are the Tax Ramifications

Tax season is fast approaching and many people have questions regarding the tax impact of debt forgiveness. During our recent real estate boom many people overextended themselves and their homes were forced into foreclosure. The next step is determining whether or not they will have a resulting tax liability.

As interest rates continue to rise and properties continue to drop in value, many families are finding themselves in a place where the value of their home is worth less than the value of their mortgage.  On top of this problem, many home owner’s mortgage payments also continue to rise, leaving many without the means to pay them, and facing foreclosure, with little to no knowledge about the tax ramifications of their problem, or their options.

Many opponents of a settlement use this possibility of paying taxes on forgiven debt as a leading reason to dissuade people from taking this route. What these opponents fail to mention is the fact that in many cases you are not required to pay taxes on canceled debt due to the IRS’s insolvency rule. You do not have to file bankruptcy to prove you are insolvent or unable to pay back your debt. Another thing to consider is even if you are somehow required to pay taxes on forgiven debt you will likely still come out ahead since the negotiated amount plus taxes will be far less than the amount you originally owed.

Now just because your debt is recourse does not mean that you automatically have a tax problem. Generally, debt forgiveness is taxable. But there are many exclusions that you may qualify for depending on your situation.