As an investor, how can I avoid paying taxes on forgiven debt?
Under the Mortgage Forgiveness Debt Relief Act of 2007, primary residence homeowners are exempt from taxes on canceled mortgage debt but investors are not. There are a couple of ways an investor can avoid paying taxes on forgiven debt, but it is best to consult with a tax advisor to strategize ways to minimize tax liability. Generally speaking, an investor is exempt from tax liability on imputed income through:
Proving insolvency. If a borrower is financially insolvent when he surrenders the mortgaged property to the lender voluntarily or through foreclosure, there will be no imputed or taxable income.
Filing bankruptcy. A borrower who files bankruptcy is presumed to be insolvent, so a bankrupt debtor is unlikely to be liable for imputed income because the bankruptcy discharges personal liability under a mortgage note.
Offsetting imputed debt forgiveness income with corresponding tax losses. For example, if a lender forecloses on a parcel of income producing rental property, the taxpayer may be able to report an operating loss to offset imputed income from debt forgiveness in the same year with income reported by the lender on the 1099C.
The tax laws can be tricky around this subject and it is best to consult a tax advisor to determine the best course of action to minimize tax liability resulting from forgiven debt.
If you have any other questions about foreclosed investments, please contact us.