For your principal residence the feds allow you to exclude up to $2 million of qualified mortgage indebtedness under the Mortgage Forgiveness Debt Relief Act of 2007, and California allows the same exclusion, but limits the debt to be excluded to $500,000. If the Act does not provide sufficient coverage or this is not your principal residence or qualified residence indebtedness then you can look to exclude the income under IRC Section 108 if you are insolvent or discharge the debt in a bankruptcy.
Any individual seeking legal advice for their own situation should retain their own legal counsel as this response provides information that is general in nature and not specific to any person's unique situation. Circular 230 Disclaimer - Advice given in this response cannot be used to eliminate penalties with the IRS or any other governmental agency.
Yes, if you meet all of the criteria. Under the federal Mortgage Debt Forgiveness Tax Relief Act of 2007 (applicable till the end of 2012), you will not need to pay any income tax on canceled debt (which is the unpaid loan balance that is forgiven by lender) resulting from a foreclosure, short sale or deed in lieu of foreclosure if you as the borrower satisfy certain conditions for mortgage tax relief (e.g., principal residence, owned for at least 2 years, debt amount of $2 million or less).
However, the Mortgage Debt Forgiveness Tax Relief Act of 2007 does not apply if the property is not a "principal residence". IRS Code section 121 defines "principal residence" as: ". . . during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years or more. "
For more information on debt forgiveness, 1099-A, and 1099-C, see:
There is also an IRS Publication 4681:
The information presented here is general in nature and is not intended, nor should be construed, as legal advice. This posting does not create any attorney-client relationship with the author (who is only admitted to practice law in the State of California). For specific advice about your particular situation, consult your own attorney.
If you received a 1099-C, and it was related to forgiveness of debt on your principal residence, you can file a Form 982. This can also apply if it was not your principal residence, but you were insolvent at the time.