If you are a homeowner whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012, you may be able to claim special tax relief and exclude the debt forgiven from your income.

Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million ($1 million for a married person filing a separate return) of debt forgiven on your principal residence.

You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure. The debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

Debt forgiven on second homes, rental property, business property, credit cards or car loans do not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

My sister and her husband received a 1099-C for a property they had purchased for their children to live in. The 1099-C stated the assessed value of the property was $65,000, but we knew the property had sold for $1200.00 after repossession. We contacted the assessor and received a statement of value on the home, attached it to the income tax return and was able to reduce the amount of tax they would have been required to pay.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit http://www.irs.gov. A good resource is IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments.

You can also use the Interactive Tax Assistant available on the IRS website to determine if the cancellation of debt is taxable. The ITA tool is a tax law resource that takes you through a series of questions and provides you with responses to tax law questions

Taxpayers may obtain copies of IRS publications and forms either by downloading them from http://www.irs.gov or by calling 800-TAX-FORM (800-829-3676).