The housing market landed with a thud in 2009 and the US experienced a rapid rise in foreclosures which, in turn, drove many financial lenders out of business. An unsuccessful stabilization attempt was made by the Government. His approach was to provide money to mortgage financial institutions and not to homeowners. In most cases, taxpayers will receive a tax form, known as a 1099-C, if they have had to go through the process of an actual short sale or foreclosure. Due to these cases, the financial mortgage lender is in charge of providing these 1099-C tax forms and, in turn, will not pursue a deficiency judgment. This was said to be great news. With this method, the amount of debt that is written off is shown as income. Please note that there are always exceptions to the rule.
Below are some of the exceptions to the rules you will encounter.
Exception A – If you have had a foreclosure on your home, box #2 on your 1099-C will have this amount listed as a forgiven debt. Under normal circumstances, during a local authority short sale of your home, your home will be purchased by the financial mortgage lender and then converted to what is known as an REO, also known as Real Estate Owned. The main intention of the financial lender is to sell the house again in the shortest possible time, however, in some cases, this could take them literally months. There is a light at the end of the tunnel, however, the amount of debt canceled will be made using the fair market value of the home, which you can locate in box #7 of your 1099-C tax form. This is essential as the amount that differs between the loan amount and the fair market value is the amount you need to be concerned about and this amount will be shown in box #2. Please note that if this is your place of principal residence , The Mortgage Debt Relief Act of 2007 states that the amount of canceled debt is not posted as income to you.
Exception B – If you have had a short sale on your home, this technically means that your home was sold with the approval of your financial lender at a discount rate. For the short sale you will still receive a 1099-C tax form. When calculating your canceled debt, they will use the actual price you purchased your home for. Please note that if this is your primary place of residence, the Mortgage Debt Relief Act of 2007 states that the amount of canceled debt is not recognized as income for you and a 982 tax form must be prepared.
Exception C – If your canceled debt is a rental property or other type of business debt, the loss of the property will be recorded as a sale. In this case, you will be exempted from calculating the gain or loss. To ensure this is done correctly, it is recommended that you hire an experienced professional to help you deal with debt cancellation.
Exception D – Proceeds from a debt cancellation will be excluded from an insolvent buyer to the extent the liability exceeds the fair market value of all assets. In other words, if you have a debt-to-asset ratio in favor of debt, you must choose to omit a specific amount from your income amount. EXAMPLE: If you have canceled debt in the amount of $100,000.00 and have $180,000.00 in liabilities and $150,000.00 in assets, you can discharge $30,000.00. This would leave you reporting $70,000.00 instead of $100,000.00.
Exception E – This is extremely essential! In some cases, if you are married and both names are on the property deed, you may be able to obtain two 1099-C tax forms and be able to pay off the full amount of the debt. This is in lieu of a form made out to both people on the deed. This would be an essential conversation to have with your tax professional. You never want the amount in Box #2 to be reported twice on the form.
Exception F – Proceeds from the cancellation of a debt will be completely excluded after the liquidation of a bankruptcy.
The details above can help you understand the ins and outs of short sales and foreclosures and the effect they have on your taxes. Knowing the consequences early on helps avoid being caught off guard later on.
