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How long ago did you purchase this home and how long have you lived there?
Hello again Customer,
Thank you for the additional information.
Normally when you have a debt that is canceled or forgiven, you are responsible for paying taxes on the amount of the forgiven loan. That is what Putnam was referring to when they said you would have to pay taxes on the defaulted loan.
However, due to the recent mortgage lending crisis in our country, Congress has enacted temporary legislation which allows taxpayers to exclude canceled debt from a foreclosure on their primary home from being taxable income.
The Mortgage Forgiveness Debt Relief Act of 2007 allows you to exclude certain canceled debt on your principal residence from your income. It applies to mortgage debts that are canceled or modified during the calendar years of 2007 through 2011 . You would still receive a 1099-C form from your bank showing the amount of the debt that was canceled, but you will file Form 982 which you attach to your tax return, and claim an exclusion for paying taxes under this new law.
You simply need to file Form 982 with your tax return. Check the box on line 1e showing that you are claiming exclusion of debt on your principal residence. And then on line #2, enter the amount of the canceled debt as shown in box #2 of the 1099-C form. You will then not need to pay taxes on this forgiven debt.
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Sorry, but you did not provide that information in your initial post, and I just assumed this was a regular mortgage.
Loans you took from your 401k account fall under a whole separate set of rules. When you take a loan from your 401k plan, you are required to pay back the loan in accordance with the terms set forth by the employer. During the months that payroll deductions were not made, you should have still made arrangements to pay your monthly loan payments on this loan.
If the loan is not brought up to date, then the 401k plan administrator is required to report the outstanding amount of the loan as a taxable distribution made to you, and you would owe taxes on that amount. This would be taxed as ordinary income, so the actual percentage of tax you end up paying would depend on your filing status and your total other income for the year, as this is what determines the tax bracket you are in.
In addition, if you are under the age of 59-1/2, then you would also owe an early withdrawal penalty of 10% in addition to the regular income taxes that are due.
There is really nothing you can do to avoid this situation other than pay the balance you owe to bring your loan payments up to date. You may want to consider taking out a home equity loan or a loan from another source to pay up your 401k loan to avoid this taxable situation.
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I am sorry if you did not find this answer helpful, but I can only provide you with information based on what the laws are. I cannot provide alternative solutions to you which do not exist. If there was a way for you to avoid paying taxes on this distribution other than bringing your loan account up to date, I would be more than happy to provide you with that information.
The letter which said the early withdrawal penalty "may" apply is simply a form letter where they use generic language, as they do not know how these funds were used. The IRS allows the 10% early withdrawal penalty to be waived only if the funds are used for one of the following reasons:
You used these funds for the purchase of a home, so there are no exceptions in your case which apply to the early withdrawal penalty.
You can always request that the early withdrawal penalty be waived, but I can guarantee you it would not even be considered unless it meets one of the above exceptions. The IRS has these rules in place and they must be followed. They do not make exceptions on a case by case.