After suffering through a foreclosure or short sale, there’s a final kick in the teeth. It comes in the form of a 1099 from your ornery mule of a lender.
For the last few years, with foreclosures in high gear, many homeowners were able to avoid paying tax on the 1099 issued after short sales and foreclosures because of the Mortgage Debt Forgiveness Act. The Mortgage Debt Forgiveness Act says that if a homeowner short sells his primary residence or is foreclosed on his primary residence then no tax is owed. This expires at the end of 2012.
What if they don’t extend this? There a few other ways to go as shown below.
First a little background: A foreclosure or short sale creates what it is called cancellation of debt income.
Income tax has to be paid on cancellation of debt income. For a short sale, the amount that’s taxable is the difference between the amount owned under the mortgage and the amount actually paid back to the lender. For foreclosures, it’s the difference between the market value of the property and the amount due on the mortgage.
If you owned your home for any 2 of the last 5 years before the foreclosure or short sale, then no tax is due on the 1099 because of the Mortgage Debt Forgiveness Act. If you rented the home out temporarily, you will still qualify as long as you meet the any 2 of the last 5 years test. If the property was never your primary residence, then you can’t use the Mortgage Debt Forgiveness Act and tax will be owed on the 1099.
If the Mortgage Debt Forgiveness Act expires, (or if you had an investment property foreclosed or that was sold short) , there are only two ways to avoid paying tax on the lender’s 1099:
1. Claim Insolvency on form 982.
2. File Bankruptcy before the 1099 is issued.
Insolvency. Insolvency means that your debts exceeded your assets on the day that debt was forgiven. This worksheet explains how to calculate insolvency. Notice that IRA and 401k accounts ARE included as assets. Overall, this seems like a simple calculation but it’s kind of tricky and anyone hanging their hat on insolvency should discuss it with their accountant well in advance of April 15. The insolvency worksheet should be filled out, form 982 is filed and then because you are insolvent no tax is owed on the 1099.
Bankruptcy. If a bankruptcy is filed before the 1099 is issued, then no tax is owed on the 1099. On your tax return, you file form 982 to show that you filed a chapter 7 or chapter 13 and that wipes out the income tax from the 1099
Foreclosures don’t seem to be slowing down and my bet is that the Mortgage Debt Forgiveness Act will be extended again.
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What happens if the bank doesn’t issue a 1099-C We had a short sale in 2010, but have never been issued a 1099-C on the first mortgage (we did get one for the 2nd). I spoke with someone at the bank recently, (the ever-confounding BofA) and they said “we might issue it next year, in a few years, or never.” If they did issue it in 2015, for example, would that count as cancellation of debt in 2010 (when the short sale occurred) or 2015?
Hi,
Yes, I have had several clients who never received a 1099.
I would say that if you did not receive it by February 2011, then the lender is not going to issue it.
The year that the foreclosure concludes in is the year that the cancellation of debt occurs.
Thanks.
Tom
The court date for our foreclosure was at the end of July/early August of this year. The auction is scheduled for 1/3/13. Do we still qualify for the MDFA? What is considered the conclusion of the foreclosure?
JB, You must live in one of the collar counties. Cook auctions happen quickly, like 30 days. I would say that you will not qualify for the MDFA if the sheriff’s sale is in January 2013. Hopefully, it will be extended. Best of luck. Tom