Beware of “Collectibles” as IRA Investments

It may come as a surprise to some, but debt forgiveness often constitutes “income” as far as Uncle Sam is concerned.  And that might mean tax on that income – then again, it might not.

The Revenooers recently issued Tax Tip 2012-39 which folks facing debt restructuring ought to check out.  That Tip makes note of ten facts about mortgage debt forgiveness.

  1. Generally, debt forgiveness results in taxable income, but under the “Mortgage Forgiveness Debt Relief Act of 2007,” folks may be able to exclude up to $2 million of debt forgiven on their principal residence.
  2. If you’re a married bloke, filing a separate return, the exclusion is limited to $1 million.
  3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt actually “forgiven” in a foreclosure.
  4. A basic requirement under these rules is that the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.
  5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualifies for exclusion.
  6. But refi proceeds used for other purposes (such as to pay off all of that credit card debt you have racked up) do not qualify for exclusion.
  7. Check out IRS Form 982 and carefully follow its instructions if you qualify for exclusion, and attach that form to your 1040 for the tax year in which the debt was forgiven.
  8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify, though in some cases there may be other provisions of the law which could allow you an excuse – most commonly, these provisions apply if you are “insolvent.”
  9. And if your lender is kind enough to excuse your debt, he will undoubtedly send you a Form 1099-C, which means the Revenooers (who will also get a copy) will be checking your return for proper reporting of the debt relief under the rules.

10.  Therefore, check our Form 1099-C carefully and make sure it’s accurate – its contents will have a significant impact on the tax treatment of your debt relief!

This area of the tax law is not for do-it-yourselfers.  The rules are tricky, and even if you

insist on doing your own returns on Turbo Tax, check with a tax pro.  Also, don’t automatically assume that the state(s) in which you file agree with the IRS rules all the way down the line!

CONSULT YOUR TAX ADVISOR – This article contains general information about various tax matters.  You should consult your CPA regarding the implications to your own particular situation.

Jeff Quinn, the author of this article, is a shareholder in Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno.  He can be reached at 831-7288, welcomes comments at jquinn@ashleyquinncpas.com, and invites readers to consider his other commentary at http://blog.nolo.com/taxes.

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