Is HAFA Relocation Assistance Taxable?

The Home Affordable Foreclosure Alternatives (HAFA) program was a federal initiative designed to help homeowners who could not qualify for a loan modification avoid foreclosure. It offered alternatives like a short sale or a Deed-in-Lieu of Foreclosure (DIL). A feature of the program was a relocation assistance payment, intended to help homeowners with moving expenses after transitioning out of their property. While the HAFA program officially concluded at the end of 2016, individuals who participated may still be navigating the tax consequences of the payments they received.

Taxability of the Relocation Payment

The relocation assistance payment received under the HAFA program is considered taxable income by the Internal Revenue Service (IRS). This payment is not treated as a non-taxable gift. Instead, the IRS views it as compensation for the homeowner’s cooperation in the short sale or DIL process, which helps the mortgage servicer mitigate losses associated with a foreclosure.

For the year in which the relocation payment was made, the mortgage servicer that disbursed the funds was required to issue a Form 1099-MISC, “Miscellaneous Information,” to the homeowner. This form reports the amount of the payment to both the recipient and the IRS. The amount is shown in Box 3, “Other income.”

Reporting the Payment on Your Tax Return

When you receive a Form 1099-MISC for HAFA relocation assistance, you must report that income on your federal tax return. The amount shown on the form needs to be transferred to the appropriate line on your Form 1040, “U.S. Individual Income Tax Return.”

This type of income is reported on Schedule 1 (Form 1040), “Additional Income and Adjustments to Income.” You would include the amount from your Form 1099-MISC on the line for “Other income.” The total from this schedule then flows to the main Form 1040, where it is included in your adjusted gross income calculation.

It is important to ensure the income is not omitted from your return. Failing to report the payment after the servicer has issued a Form 1099-MISC will likely trigger a notice from the IRS, as their records will show a discrepancy between the income reported by the payer and the income reported by the taxpayer.

Tax Implications of Canceled Mortgage Debt

Separate from the relocation payment, participating in a HAFA short sale or DIL resulted in the cancellation of the remaining mortgage debt. Under federal tax law, canceled or forgiven debt is considered taxable income to the borrower. This means that if a lender forgives a $50,000 loan balance after a short sale, that $50,000 could be counted as income on your tax return.

However, an exception applied. The Mortgage Forgiveness Debt Relief Act of 2007 created a tax break for homeowners that has been extended through 2025. This provision allows taxpayers to exclude forgiven debt on their principal residence from their taxable income, up to a limit of $750,000. This relief helps homeowners avoid a tax bill on “phantom income” they never actually received.

To claim this exclusion, taxpayers were required to file Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness,” with their tax return for the year the debt was canceled. On this form, the taxpayer would indicate that the canceled debt was qualified principal residence indebtedness. This form is not for reporting income but for notifying the IRS that you are legally excluding the canceled debt from your income under a specific provision of the tax code.