Skipped Mortgage Payments in 2020?

If you are one of the millions of Americans who received forbearance and were allowed to pause your monthly mortgage payments during the past year, that could have implications when it comes time to file your taxes this year and in the years to come.

Exactly how will forbearance affect your ability to deduct the interest?

Individuals typically use what’s called a cash-basis method of accounting. That means you report income if you receive income. (Whereas businesses report income when they’ve earned it for doing a service, even if they have yet to receive payment.) The same goes for a deduction: You can only deduct mortgage interest if you paid interest. 

What borrowers in this position need to be aware of is Form 1098, the mortgage interest statement provided to borrowers by their lenders or servicers for tax purposes. The document will list how much was paid in interest for the previous year, which borrowers can use to calculate whether they should take the deduction. In many cases, borrowers entered into forbearance as a precautionary measure but continued making monthly payments. 

These individuals should pay especially close attention to their Form 1098 to ensure the amount listed is accurate. If it’s not, though, don’t just go ahead and report to the IRS what you think the number should be. That could get you an automated letter from the IRS saying the numbers don’t match. 

Tax experts advise contacting your mortgage lender if the information on Form 1098 appears to be incorrect for any reason. Ultimately, borrowers who requested forbearance likely will have paid less on mortgage interest last year. That could make the mortgage interest deduction pointless for many people. You probably weren’t going to itemize anyway because of the increased standard deduction due to tax reform.

Future considerations

If you’re still in forbearance and not yet making payments, pay close attention to what happens when you exit forbearance. You’ll generally have a range of options to repay the debt you owe as a lump sum, on a payment plan or at the end of your loan’s payment period. 

Borrowers in severe distress may be able to modify their loans to adjust the interest rate or other factors to make monthly payments less of a hardship. Some borrowers might even find themselves in a situation where they have some of their debt forgiven. Canceled debt can be taxable—and when it is, it’s sometimes taxed like ordinary income. 

The Mortgage Debt Relief Act of 2007 excludes any discharged debt up to $2 million for people’s primary residences. As a result, most homeowners won’t need to worry about taxes on that forgiven debt. If for some reason they do, they will receive a Form 1099-C from the lender displaying the amount of canceled debt, which is then added to the borrower’s gross income when they report their taxes. 

And if a homeowner ultimately loses their home to foreclosure or sells the home to the lender down the road, the situation is considered a sale for tax purposes. Capital gains or losses may apply, but borrowers in this scenario need not worry about forgiven debt.

Sign up to get “My Two Cents.” It’s a blog where I share my thoughts on everything related to real estate finance.