Bankruptcy may cancel your debts and obligations, but secured lenders keep their debts alive in their mortgages and foreclosures may continue.
Q: Due to my cancer diagnosis, and subsequent expenses, my wife and I filed bankruptcy in 2010. Just a few days ago we received a 1099-C from the second mortgage holder indicating they had cancelled the debt on July 28, 2011.
I called my lender and was told that while they have cancelled the debt they plan to retain the note and trust deed as a lien. I am more than confused! Since the note and trust deed are associated with a debt, and since the debt has been cancelled (with its attendant IRS consequences) what possible justification can the bank have to refuse to surrender the note and sign the mortgage reconveyance?
A: You are confused. Your bankruptcy may have released you from your personal obligation to repay the debt, but that doesn’t mean that the lender gives up its claim on the property. The debt is evidenced by a note that requires you to pay the lender back money you borrowed. The lender takes your property as collateral in case you fail to pay.
In your case, you didn’t pay and your personal obligation to repay the debt was wiped out in the bankruptcy. However the lender has a lien on your home that they have a right to enforce to seek repayment.
Given this situation you can see that the lender may not seek repayment from you but can seek to sell the property to get what it is owed. The lender is under no obligation to extinguish the debt and the lien on the property. They were only obligated under your bankruptcy case not to seek money from you.
As far as the IRS goes, you probably have no phantom income to report. Phantom income is created when a lender forgives a debt. That forgiveness is considered income to you and that is why it was reported to the IRS. For some people that could be a problem. However, under certain rule changes, you won’t have to pay income taxes on that forgiveness if the loan was on your primary residence.
And as far as other borrowers are concerned, debt forgiveness on primary residences for situations like yours won’t be considered taxable for borrowers through the end of this year. However, if your debt is forgiven next year and the tax rules go back to the way they were, you’d have to pay income taxes on the amount of debt forgiven.
If you own an investment property, second home, vacation home or time share and a lender forgives the debt and sends you a 1099, you will have to pay income taxes on the amount of debt that was forgiven.
Thanks for that post. That is a common cause of misunderstanding among my clients. It is difficult to understand the difference between a personal debt (wiped out by the bankruptcy) and a property lien (which remains on the property).
People should also know that if their home is foreclosed the Lender can also file a deficiency judgment to collect the remaining balance of the loan which was not recovered in the foreclosure. Lots of tricky issues.