Short Sale Income and IRS form 1099-C

Sell a home in a short sale. You may have to pay taxes on the sale even if you lost money and may receive an IRS form 1099c

Q: I formerly financed a property in Denver, Colorado that successfully underwent a short sale last year. I lived in the property from 2005 to 2008 and relocated to take a job in Ohio in 2008.

I recently received a 1099C Form indicating cancellation of debt from the two lenders to the Denver properties. After reading some about the cancellation of debt, I am assuming I am responsible for claiming that cancellation of the lender’s debt as income in my 2011 federal income tax return. Am I correct?

A: The 1099C is a tax form created for tax reporting purposes to evidence a cancellation of a debt by a lender with a borrower. Generally, that cancellation of the debt might be income to a borrower.

If you had a business and borrowed $100,000, the bank would actually give you that money with the expectation that you would repay that money. However, if your circumstances change and you are unable to repay the loan and the lender cancels and forgives the debt, you received the benefit of the money but never repaid it. For that reason, the forgiveness of that debt is reported to the IRS and to the individual with form 1099C.

Just because you received the form does not mean that you owe money to the IRS. Several years ago, the Federal government passed a law (Mortgage Forgiveness Debt Relief Act of 2007) that allowed people to avoid paying tax on forgiven debt under some circumstances.

According to the IRS, there are several factors to consider and that go into determining whether you will owe income tax on this forgiven debt, which is also known as phantom income:

1. Was the debt greater than $2 million? You may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit drops to $1 million for a person that files a separate return. (For a married couple filing separately, each can exclude $1 million.)

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt, to buy a car or fund educational expenses – do not qualify for the exclusion.

7. You will need to file Form 982 with your tax return to obtain the benefit.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans do not qualify for the tax relief provision. But you might qualify under other provisions of the tax code. IRS Form 982 provides more information.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. The form will show the amount of debt forgiven and the fair market value of any property foreclosed. You need to make sure the information on the form is accurate. If the information is inaccurate, you need to contact the lender immediately.

The key to your question is whether the home was your principal residence at the time of the foreclosure or short sale. You should talk to your accountant or other tax professional to determine if the Denver home was your principal residence for purposes of the Debt Forgiveness Act.

If the property can be considered your primary residence, you probably won’t have to pay tax on the forgiven debt, but if it is considered a second home, then you will have to pay tax on that phantom income.


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5 Responses to Short Sale Income and IRS form 1099-C

  1. Scott says:

    Ilyce,

    Very nicely detailed answer! However, I didn’t see any mention of the expiration (or possible extension) of the Debt Forgiveness Act. Isn’t the Debt Forgiveness Act due to expire the end of 2012? That’s what I understand, so I’m very surprised there’s been so little mention of this by real estate experts and journalists.

    Have you heard or believe that the Debt Forgiveness Act will be extended beyond 2012?

    Thank you.

    Scott

  2. Susan says:

    What happens when the lender doesn’t issue a 1099-C? I was told they were not issuing a 1099-C on my FHA short sale which I would think means they are not reporting it as a loss? Thoughts?

    • teri says:

      I was also told by my lender that a 1099c would not be issued by them for my FHA loan short sale but that it would actually be issued by HUD. I have put in multiple calls to HUDs servicing center to report that I still have not received my 1099c, as of March 3, 2014, and to request an additional copy. No one has been able to help me and no one will return my calls. I am beginning to wonder if it is reported differently being it was a government backed loaned. Meaning, being I received approval directly from the government during the short sale process, there is no need to report the income and then again prove meeting the criteria for debt forgiveness….thus it is already forgiven and this would be a redundant step. I am trying to get answers from IRS tax law department.

  3. Ray says:

    I am about to close on a short sale here in metro ATL and am being told the lender will issue this 1099C

    Can you advise a good CPA here in the ATL area that I can speak to that might be willing to help me understand if I am going to have any tax implication here loan was for $356,00 home is selling for $205,000 it is FHA

    I became medically disabled this year haven’t worked in over 5 months am awaiting SS Disability approval and could no longer afford the home.

    Thanks for any direction you can provide.

  4. TIMOTHY SKOWRONSKI says:

    MY WIFE AND I WHERE GOING TO GO THROUGH A SHORT SALE ON OUR VACATION RENTAL CLOSE TO DISNEY THAT WAS USED FOR INCOME ONLY WE DO NOT KNOW IF THE 1099-C WE COULD RECEIVE IF OUR MORTGAGE DEPT WAS FORGIVEN CAN BE REPORTED UNDER LONG TERM CAPITAL LOSSES. BECAUSE WE HAVE CAPITAL LOSS CARYOVER FROM THE PAST THAT WOULD MORE THAN COVER IT. SO WE HAVE TO KNOW WHAT LINE ON A 1040 FEDERAL TAX FORM DOES A 1099-C ACTUALLY HAVE TO BE REPORTED ON , AND CAN IT BE REPORTED AS A CAPITAL GAIN OR MUST IT BE REPORTED ON THE LINE FOR ORDINARY INCOME, OR INTEREST OR ^OTHER INCOME*

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