Mark Damon

Many of you know that President Bush signed a bill for the passage of the "Mortgage Forgiveness Debt Relief Act of 2007" for excluding from income debt cancelled by foreclosure. Prior to October 2007, when a home foreclosed, and debt was forgiven on a mortgage loan balance outstanding, it was usually included on your individual income tax return as taxable income. Moreover, another remedy in the past and still available today was to declare insolvency, also to exclude the cancelled debt as taxable income.

Something you should know in the bill is that you can only exclude the cancelled debt up to your basis in your residence, which includes your original purchase price or price for construction of your home plus improvements made on your residence.

Extreme scenario: if you purchased your home for $200,000 and cashed out equity and now owed on a balance of $700,000 and not all of that cash out was used to improve the home you cannot exclude the entire difference of $500,000. What this means is that if you cashed out your equity of $500,000 and only $100,000 went to improve your home you only have a basis of $300,000 and when your home forecloses for the $700,000 you may have a gain of somewhere around $400,000.

However, if you meet the ownership test of at least two years and day over the last five years, you can still exclude the gain on the cancelled debt of up to $250,000 as an individual and $500,000 if married.

I know, a bit extreme, but just wanted to give you a worst case scenario. Of course your okay if you're married, but I don't believe this will really happen to anyone married or single.

Now any of you or anyone you know that is flipping houses for profit and has to let one or two go to foreclosure, they may be able to declare insolvency and this does not mean they have to file bankruptcy. They just need to show that their debts are more then their assets.

Another, scenario for rental property that forecloses is offsetting the canceled debt income by the capital losses after the rental is foreclosed. Meaning if the foreclosed value is less than the purchase price of the rental a capital loss is created that can go against the cancelled debt. This only applies to our rental scenario it does not apply to personal residences.

I may have given you too much information and not enough explanation. I really don't want to give you a headache; however, if you do find yourself in this situation or someone you know is in this situation, I am here to offer my help.