You should be aware of “Cancellation of Debt Income” because it may have an impact on your tax liability due to the IRS Form 1099C that you may receive from a settled debt or lending institution should you have a foreclosure or short sale. There are several events in your life that could trigger a 1099C. In this day and age with so many homes in foreclosure and homeowners doing short sales on their homes, and overburdened credit card debt settlement, you must look for the tax liability you may face. This means when your lender or creditor completes your foreclosure or short sale your home or debt settlement the deficiency balance could trigger the lender to send you, the consumer, an IRS Form 1099C for the amount they “forgave”, if the cancellation of debt exceeds $600.
The creditor could be your lending institution, the holder of a personal note, a trustee for multiple owners of a single note or a governmental unit, but also includes individuals and business organizations of all kinds. This form would be sent to the consumer by the 31st of January of the year following the foreclosure or cancellation of debt. This form would need to be included with the information you give to your tax accountant or tax preparation specialist. The cancellation of debt amount would be determined by the difference between what you paid the lender or creditor and what the balance was at the time of the foreclosure or settlement. For example, if your loan was for $100,000 and it was settled for $80,000 then your 1099C would reflect $20,000 in taxable cancellation income. Another example, if your credit card company settles a $5,000 debt for $2,500 then your 1099C would reflect $2,500 taxable income. It is important to note that homeowners are not permitted under the IRS statutes to claim losses as a deduction due to foreclosure.
There are some exceptions to this rule and they include; Bankruptcy: Debts discharged through bankruptcy are not considered taxable income. Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets. Insolvency can be fairly complex to determine and the assistance of a tax professional is recommended if you believe you qualify for this exception. 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. Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.
You should consult with your tax professional to determine if this could pertain to your individual situation and your tax professional would be able to advise you and file your return correctly.