Posted in Blog  
  on Nov 05, 2014

Cancellation of Debt on Rental Property

There are a lot of unique tax circumstances that can hit an investor at any given time. One of the most common issues that landlords face is a cancellation of debt on a rental property. The removal of a debt is a good thing and it brings a sense of relief, but that's not the end of the story. A debt cancellation is viewed by taxing authorities as earned income. In many circumstances, this must be reported at the end of the year and it can increase tax liabilities.

Mortgage Forgiveness Does Not Apply To a Rental


Many homeowners have been able to get out of large amounts of debt through the foreclosure process, deed-in-lieu, or through short sales thanks to the Mortgage Debt Relief Act. The only problem is that many landlords believe they can take advantage of this law, but they cannot. This income forgiveness does not apply to a rental property.

Here's an example of the income liability that you'd be facing at tax season. Your rental property has a mortgage for $200,000 and a value of $250,000. You can't get a tenant and so you can't make the mortgage payments. The home goes into foreclosure and you lose the rights to the property because the bank takes it back. They sell the property for $165,000 on the open market and then forgive the rest of your mortgage.



Your total income that must be reported: $35,000. This is because having a lien holder taking possession of a property does not automatically remove a loan. Some landlords have also found this out the hard way as well. Instead of having the debt forgiven, they're finding collection notices in the mail.

There Is One Exception To This Rule


The only time a rental property does not need to report a canceled debt as income is when that debt is $600 or less. In this circumstance, not enough income has been generated to warrant the filing. The same is true for income that is earned through traditional means as well. As long as the initial amount threshold is never met, then the money does not need to be reported.

When would a landlord have $600 or less in a canceled debt on a rental property? A forgiven utility bill is the most common place this is seen. Discounts or debt forgiveness from repair personnel would also potentially qualify for this action.



The only time a landlord would be able to have their mortgage debt canceled and the income forgiven is if they are living in the home as their primary residence. In this specific circumstance, a portion of the income or even all of it may qualify for debt forgiveness without the phantom income charge on taxes.

The cancellation of debt on a rental property can relieve a landlord of their primary responsibility, but that only lasts until tax season rolls around. Know how much income you'll need to report and plan your tax payments accordingly so that you aren't surprised by the final bill that becomes due.

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