The Mortgage Forgiveness Debt Relief Act of 2007 temporarily suspended income tax on forgiven debt from bankruptcy or refinancing for primary residences up to $2 million. It does not cover rental or second homes, and was extended through 2012 due to the financial crisis.
The Mortgage Forgiveness Debt Relief Act is a 2007 law passed by the United States Congress at the urging of President George W. Bush. The law allowed for a temporary change in tax laws regarding debt relief or refinancing a home. Under previous statutes, taxpayers who had debt forgiven through bankruptcy or refinancing had to pay income taxes on the amount forgiven. With the passage of the law, in many cases this type of taxation has been temporarily suspended.
The reasoning behind the Mortgage Forgiveness Debt Relief Act of 2007 is relatively simple. Typically, people who file for bankruptcy or choose to refinance a primary residence do so as a reaction to financial stress or crisis. In 2007, as the US housing market crashed, many homeowners and debtors were forced into foreclosures, bankruptcies and refinancing as interest rates soared and employment fell. In order to reduce the additional tax burden on people already struggling to service debts, the law ended the income tax levied on certain types of forgiven debt.
This law only covers certain types of canceled or modified debt. In general, the debt in question must come from loans used to purchase, upgrade, or refinance a primary residence. Debt cancellation does not extend to rental properties, nor to properties used as a second home or holiday home. Credit card, student loan, and auto loan debt canceled through bankruptcy or refinancing may or may not be eligible, depending on the specific type of loan and the forgiveness program used.
In addition to limitations on the type of debt covered by the law, the Mortgage Forgiveness Debt Relief Act also has a maximum amount that can be excluded from income tax. Refinancing or debt forgiven up to $2 million US dollars (USD) are eligible for the exclusion, but amounts above this number may be taxed as usual. For married individuals filing separate tax returns, a reduced maximum of $1 million USD applies.
Originally, the law extended the tax exclusions through the year 2009. In 2008, as the financial crisis began to take hold in both the US and global economies, Congress agreed to extend the law’s protections by a longer period. The Emergency Economic Stabilization Act of 2008 included a number of new provisions to help bring stability to the US market, as well as extending the Mortgage Forgiveness Debt Relief Act through 2012.
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