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Banks Forgiving Phantom Debts for Bankrupt Homeowners

Does bankruptcy discharge your mortgage debt?

You would be inclined to believe so, right?

According to letters sent out by several banks to former homeowners, that didn't look like the case. A columnist for The New York Times reports the banks are now claiming to be forgiving debts that have long been let go.

Sound confusing? It is.

As the Times columnist explains, banks agreed to a settlement in February, obligating the banks to pay $25 billion after their mortgage practices were brought into concern.

As part of the settlement, the government offered to give the banks credits against the amounts they agreed to pay, according to the Times.

So the banks apparently began forgiving phantom debts. And the worst part about all of this is something called "cancellation of indebtedness income." It's an IRS term that essentially taxes income from the cancellation of debt (COD).

While some types of COD income can be excluded from taxation, such as debts discharged in bankruptcy or debts discharged through the restructuring of a mortgage on a principal place of residence, not all COD income is tax-free.

And that's raising issues for some people, as some banks are sending letters claiming that customers' "forgiven" debts -- debts that actually had already been discharged -- will be reported to the IRS. (By reporting these debts as "forgiven," the banks may be able to claim credit against the amount they agreed to pay in the settlement deal, the Times suggests.)

If that happens, then customers may have the burden of proving to the IRS that the banks' claims of purportedly "forgiven" debts were wrong, the Times columnist opined.

Another issue posed by these letters is that some banks claim they still have liens on the properties in question. In the case of bankruptcy, the liens would have been extinguished.

So why forgive debts that have already been forgiven? And why claim liens that no longer exist? When asked, bank representatives offered "unsatisfying answers," the Times columnist wrote. Customers who received these forgiveness letters may just have to wait and see what happens.

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