Back in 2007 my wife and I seperated temporarily.

During that time my wife purchased a home with a friend as the co-borrower.

Several months later my wife and I reconciled and she moved back in.

The friend agreed to stay in the house and continue with the mortgage on the new house.

The friend fell behind and instead of talking to us about what our options were and giving us the "head's up", she literally packed her stuff and abandoned the property. By the time we realized she moved out and left without any notice, the mortgage was over 2 months behind. My wife let it slip into foreclosuresince in this current market, the house was upside down in equity.

My tax returns have always been filed jointly with my wife and we never claimed mortgage interest on this house. We allowed my wife's friend to claim the mortgage interest on her tax return.

Fast forward to this tax season, my wife received a 1099-c cancellation of debt tax document on that property (naturally). I know there is a new forgiveness law for this type of 1099, however it states it is only for primary residential property. The property started as a primary residence but like I said my wife moved back in with me months later. We would like to take advantage of the new law that allows forgiveness of debt on this property but I am afraid to file jointly as usual with the primary residence being the house I have owned for several years but then also trying to take adavntage of this forgiveness of debt law which is only supposed to be on the primary residence.

I do not want the IRS to look at this like we are just claiming it was a primary residence when it wasn't to take advanatage of this new law. Yes we have the mortgage documents to show it was a primary residence property at the time of purchase but then if they ask why she moved out months later, we do not want that to start a whole new topic of possible mortgage fraud! In other words, we do not want anything to look like my wife just CLAIMED it was a primary residence to get a better rate when it really was a non-owner occupied property. Again the house was never an investment, we never claimed mortgage interest, never claimed deductions on the property either.

Should we file jointly as usual? Or should we both file individually? Should we simply just bring this to a CPA or tax preparer? I have been filing my own taxes for years now and our tax returns year in year out have been as basic as a tax return could possibly be... until now! Any advice or insight?

Hmmm... an interesting case. I am surprised no one answered it.

In my opinion, the BEST way to handle this was for you and your wife to file Married Filing Separately and have her file the Form 982 under the Mortgage Forgiveness Debt Relief Act of 2007.

Presumably, when you got no answer, you went to a local tax professional. I would be interested in knowing how this issue was handled.

I strongly disagree with ATE's suggestion. If she lived in the house for only a few months in 2007, and you have both lived together in your main home before and since then, then the house that was foreclosed upon is clearly not her principal residence.

TTE:

I see your point, but, at the same time, the house she bought with her friend WAS where she lived during the separation period. For this reason, I think the IRS would allow her to claim that home as her primary residence for Form 982 purposes.

Clearly, she should have taken her name off the deed when she and her husband reconciled, but that error could end up costing her dearly in terms of taxes owed on the Form 1099-C income. I hope they post an answer on how they dealt with the matter.

TTE:

I see your point, but, at the same time, the house she bought with her friend WAS where she lived during the separation period. For this reason, I think the IRS would allow her to claim that home as her primary residence for Form 982 purposes.

Clearly, she should have taken her name off the deed when she and her husband reconciled, but that error could end up costing her dearly in terms of taxes owed on the Form 1099-C income. I hope they post an answer on how they dealt with the matter.

I disagree. The law defines principal residence as having the same meaning as under section 121.

Even if you just look at the instructions for the form, it states clearly that a principal residence is the home where you ordinarily live, most of the time. How does living at another place for 'a few months' in 2007 qualify the place as a principal residence.