Obama's Economy

If a homeowner is not able to exclude debt cancellation based on the Mortgage Forgiveness Debt Relief Act or any of the other exclusions, there may be relief if they can prove they were insolvent immediately prior to the cancellation.

You are insolvent when, and to the extent, your liabilities exceed the fair market value of your assets. You must determine your liabilities and the fair market value of your assets immediately before the debt cancellation in order to determine whether or not you were insolvent and the amount by which you were insolvent. Accordingly, the definition of insolvency would be when your liabilities exceed your assets at any given point in time.

For purposes of determining insolvency, your assets would include the value of everything that you own (including the assets that serve as collateral for your debt and assets that would normally be beyond the reach of your creditors under the law, such as your 401k, pension plans and the value of any other retirement accounts). Liabilities would include your debt including the entire amount of recourse debt and the amount of nonrecourse debt that is not in excess of the value of the property that is held as security by the debt. You may exclude from your income debt that is canceled when you are insolvent, but only up to the amount by which you are insolvent.

An important point to note is that the insolvency calculation should be done just before the cancellation of debt occurred. This can be difficult because often the cancellation of debt occurred several months ago.

Just consider how painful the process would be to go back six months to a year in the past and try to determine the balance in your bank account and the value of any retirement accounts. The most difficult part is trying to determine the value of your personal belongings, such as cars, furniture and other items.

This exclusion does not apply to a cancellation that occurs in a title 11 bankruptcy case. This exclusion also does not apply if the debt is qualified principal residence indebtedness (as defined by the IRS) unless you elect to apply the insolvency exclusion instead of the qualified principal residence indebtedness exclusion.

An insolvency calculation should be done with the assistance of a qualified CPA or other tax or legal professional. It is just too much for the average taxpayer to do on their own.

Additional Information:

If you are looking for FREE information on insolvency and debt cancellation or if you are trying to determine whether you qualify under the insolvency exclusion please visit our site.

This article is for informational purposes only and is not meant to be tax or legal advice. Each situation is different and you must discuss your cancellation of debt issue with a qualified tax or legal professional. This article is not written to be used for the purpose of avoiding penalties under the Internal Revenue Code.