VA Loan Forgiveness - Debt Forgiveness for U.S. Veterans

The United States military has several programs in place that are designed to help military service members and their families avoid foreclosure and manage their debt. 

Most military bases have a Family Support Center for financial counseling. The counselors can help you understand your debt and the options that are available to you. This is an invaluable resource for service members who are experiencing financial distress.

If you currently have a sub-prime mortgage and are in trouble, consider refinancing into a VA loan. The Veterans’ Benefits Improvement Act provides this option; VA loan counselors will help you navigate the process and avoid foreclosure. VA home loans are often less risky and offer more affordable interest rates to military families.

If you default on your loan, your lender may cancel or forgive the remaining portion of your debt. For example, if you borrow $20,000 and default after paying back $4,000, the lender may forgive the $16,000, which means you no longer have the obligation to repay the loan. 

In most cases the remaining amount would be taxable income. 

However, another great benefit for servicemen that are in debt concerns debt forgiveness and taxes: when filing your taxes, you may write off any percentage of forgiven debt from your taxable income; provided the debt was forgiven between the 2007 and 2012 tax years.

Debt Forgiveness and Taxes

Typically, debt forgiveness on a VA loan counts as taxable income. But due to the Mortgage Forgiveness Debt Relief Act of 2007 members of the military are eligible to exclude some of the debt forgiveness on a primary residence, up to $2 million. 

If married service members are filing returns separately, up to $1 million can be excluded.

Forgiven debt that you can exclude from your tax returns includes foreclosure mortgage debt that has been forgiven and debt that has been reduced by means of mortgage restructuring. 

The tax relief benefit is available to service members prior to foreclosure, giving those with financial troubles a jump start on gaining control of their debt.

What kind of debt is allowed for forgiveness?

The debt that qualifies for this tax exclusion is debt incurred for the purposes of purchasing a home, building a new home, or remodeling an existing home. 

To qualify for exclusion the home must be the borrower’s primary or principal residence, and it must also be the security for the debt in question.

The funds eligible for exclusion must be used for your home in order to qualify. In other words, the money cannot be used for any other purpose, such as paying off credit card debt. 

The Mortgage Forgiveness Debt Relief Act usually does not cover debt forgiveness on secondary properties like second homes, rental or business properties, or other types of debt like credit card bills or car loans. 

Forgiveness on types of debt other than a home purchase or improvement are not typically eligible for tax relief.

How to Apply for VA Loan Forgiveness

If you have debt that has been forgiven between the tax years of 2007 and 2012 that has been used on your primary residence, you may apply for tax exclusion. The special exclusion to claim on your taxes is Form 982 (or, Reduction of Tax Attributes Due to Discharge of Indebtedness). 

This form is available online at www.irs.gov. Send this completed form with your federal income tax return for the tax year in which the debt was forgiven.

In the case of debt reduction or cancellation, your lender should provide you with a Cancellation of Debt form, or Form 1099-C at the end of the fiscal year. Carefully examine this form in order to make sure there are no errors, particularly in terms of how much debt was forgiven as well as the listed price of your home. 

If any of this information is incorrect, contact your lender right away so they can make the necessary changes.

Gretchen Wegrich

Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.