‘1099-C’ Category

Debt Forgiveness Income Questions

I am always talking to people who are losing their homes through either foreclosure or a short sale.  Most of them understand that there can be inc...


I am always talking to people who are losing their homes through either foreclosure or a short sale.  Most of them understand that there can be income tax issues for both of these transactions.  I have posted here the top 10 questions that I am asked regarding the tax issues of the transactions (including debt forgiveness).

1.  What is Debt Forgiveness?

If you borrow money from a bank and the bank later forgives the debt (or a portion), you may have to include the cancelled amount in income on your tax return. When you borrowed the funds you did not have to include the proceeds in income because you had an obligation to repay the bank. When that obligation is subsequently forgiven, the amount you received as loan proceeds is reportable as income because you no longer have an obligation to repay the lender. The lender normally reports the amount of the cancelled debt to you and the IRS on Form 1099-C, Cancellation of Debt.

2.  Is Debt Forgiveness always taxable to me?

Not always. There are some exceptions. The most common situations when debt forgiveness income is not taxable involve:

  • Bankruptcy: Debts discharged through bankruptcy are normally not considered taxable income.
  • Mortgage Forgiveness Debt Relief Act: Debt forgiveness that qualifies under the Act is not taxable.
  • Insolvency: If you are insolvent when the debt was forgiven, some or all of the forgiven debt may not be taxable to you.
  • Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.

3.  What is the Mortgage Forgiveness Debt Relief Act?

The Act generally allows taxpayers to exclude debt forgiveness income on their principal residence as long as it is qualified principal residence indebtedness.  Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure qualifies for this relief.  This Act applies to debt forgiven in calendar years 2007 through 2012.

4.  I lost money on the foreclosure or short sale of my principal residence.  Can I claim a loss on my tax return?

No – any losses from the sale or foreclosure of personal property are not deductible to you in any way.

5.  I have heard about Insolvency…what does this mean?

Do not include debt forgiveness in income to the extent that you were insolvent immediately before the forgiveness.  You were insolvent immediately before the forgiveness to the extent that the total of all of your liabilities exceeded the fair market value of all of your assets immediately before the forgiveness.

6.  I lost my home through foreclosure or a short sale.  Are there tax issues?

There are two possible consequences you must consider:

  • Taxable debt forgiveness income. (note: debt forgiveness income is not taxable in the case of non-recourse loans.)
  • A reportable gain or loss from the disposition of the home (because foreclosures are treated like sales for tax purposes).

7.  What about rental properties, vacation homes and other investment real estate?

Debt forgiven on a rental property, second home, or other investment real estate does not qualify under the Mortgage Forgiveness Debt Relief Act.  With respect to rental properties, the taxpayer may be able to recognize a loss on the property but also must consider recapturing any allowable depreciation.  Dealing with tax issues associated with rental or investment property can be challenging.  Taxpayers need to make sure that they seek the assistance of a CPA or other qualified tax professional.

8.  I don’t agree with the information on the Form 1099-C.  What should I do?

You must contact the lender immediately.  The lender should issue a corrected 1099-C if the information is determined to be incorrect.  Retain all records related to the purchase of your home and all related debt.

9.  Can you give me an example?

Assume that a taxpayer purchases a principal residence for $325,000 using a down payment of $25,000 and secures a recourse first mortgage of $300,000.  Now assume that the property appreciated to $450,000 and the taxpayer took out a second mortgage for $100,000 (total debt of $400,000).  This money was used to pay off credit cards, buy a new car and take a vacation.

Let’s assume that the home is then sold through a short sale for $250,000 and the entire balance of the second mortgage is forgiven ($100,000) along with $50,000 of the first mortgage.  Assuming the debt was not discharged in bankruptcy, the taxpayer would have $50,000 of debt forgiveness income that would meet exclusion under the Mortgage Forgiveness Debt Relief Act.  The $100,000 of nonqualified debt from the second mortgage would be taxable unless the taxpayer qualified, in whole or in part, for the insolvency exclusion.

10. Will I be able to do my tax return myself?

You certainly can but I advice you against it.  There is just a lot of margin for error and you could cause yourself problems.  Seek the counsel of a qualified CPA or other tax professional.

For a FREE debt settlement review call us today at 1-877-536-9421.

Disclaimer: To ensure compliance with the requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. The information contained within this website is provided for informational purposes only and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional accountant. Presentation of the information via the Internet is not intended to create, and receipt does not constitute, an accountant-client relationship. Internet subscribers, users and online readers are advised not to act upon this information without seeking the service of a professional accountant.