Home Foreclosure and Debt Cancellation

The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for this relief.

This provision applies to debt forgiven in calendar years 2007 through 2012.Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home's value or the taxpayer's financial condition.

The amount excluded reduces the taxpayer's cost basis in the home. 

Home ForeclosureMortgage Forgiveness Debt Relief Act and California Franchise Tax Board:

For discharges occurring on or after January 1, 2009, California does not conform to the federal Mortgage Forgiveness Debt Relief Act. Amounts excluded for federal income tax purposes must be added to income for California tax purposes. However, several bills pending in the Legislature would extend and modify California mortgage forgiveness debt relief to conform more to the Federal law: AB 1779, SBX8 32, and SBX8 25.