Forgiven debt such as credit card settlements can trigger a tax bill

Getting a tax bill after you’ve gone through foreclosure is like having a bucket of ice water poured over your head after someone has made off with your pants. You’ve lost your home and probably don’t have much money, so why would you owe the IRS anything?

Here’s why: The IRS treats forgiven or canceled debt as taxable income.

For example, suppose you owe $400,000 on a home that goes into foreclosure, the bank sells it for $300,00 and writes off the rest of your loan. Under the tax code, the $100,000 in forgiven debt is taxable income.

In 2007, Congress enacted legislation that excludes up to $2 million in forgiven mortgage debt from taxes, as long as the loan was used to buy or improve the taxpayer’s primary residence. That means most people who lost their homes to foreclosure last year won’t have to pay taxes on the canceled debt, says Robin Christian, tax analyst for Thomson Reuters.

There are limits, though, to this relief. The exclusion is scheduled to expire at the end of 2012, which means homeowners who are starting to fall behind on their payments could face a nasty tax surprise in 2013. And individuals who have had other types of debts forgiven by their lenders could be in trouble right now.

via Forgiven debt such as credit card settlements can trigger a tax bill –

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