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Exclusion from Income for Certain Cancellation of Debt on
Principal Residence

The Mortgage Forgiveness Debt Relief Act of 2007 allows individuals to
exclude from gross income a discharge of qualified principal residence
indebtedness (defined below). This exclusion applies to discharges made
after 2006 and before 2010. Additionally, the basis of the principal
residence must be reduced (but not below zero) by the amount excluded
from gross income. To claim the exclusion, you must file Form 982,
Reduction of Tax Attributes Due to Discharge of Indebtedness (and
Section 1082 Basis Adjustment), with your tax return.

Qualified principal residence indebtedness
This is a mortgage you took out to buy, build, or substantially improve
your principal residence. It also must be secured by your principal
residence. If the amount of your original mortgage is more than the cost
of your principal residence plus the cost of any substantial
improvements, only the debt that is not more than the cost of your
principal residence plus improvements is qualified principal residence
indebtedness. Any debt that is secured by your principal residence you
use to refinance qualified principal residence indebtedness is treated as
qualified principal residence indebtedness, but only up to the amount of
the old mortgage principal just before the refinancing. Any additional
debt you used to substantially improve your principal residence is also
treated as qualified principal residence indebtedness.

Principal residence
Your principal residence is the home where you ordinarily live most of the
time. You can have only one principal residence at any one time.

Amount eligible for the exclusion.
The maximum amount you can treat as qualified principal residence
indebtedness in $2 million ($1 million if married filing separately). You
cannot exclude from gross income discharge of qualified principal
residence indebtedness if the discharge was for services performed for
the lender or on account of any other factor not directly related to a
decline in the value of your residence or to your financial condition.

Ordering rule
If only a part of a loan is qualified principal residence indebtedness, the
exclusion applies only to the extent the amount discharged exceeds the
amount of the loan (immediately before the discharge) that is not
qualified principal residence indebtedness. For example, assume your
principal residence is secured by a debt of $1 million, of which $800,000
is qualified principal residence indebtedness. If your residence is sold for
$700,000 and $300,000 of debt is discharged, only $100,000 of the debt
discharged may be excluded (the $300,000 that was discharged minus
the $200,000 of nonqualified debt).