Tax on Forgiven Debt 1099/982

[bonkers65]

My brother is trying to short sell his home but I believe he's either getting bad info or misunderstanding the info he's getting (he's stressed so I could see that). He told me that he won't get 1099'd on his short sell and therefore won't have to pay taxes on the cancelled debt due to the Debt Forgiveness Act of 2007. This just didn't sound right to me.

Please correct me if I'm wrong but while there is a DFA2007 you will still always (??) get a 1099. That is the law, not some arbitrary decision by the lender (??). How much of that forgiven debt is taxable depends on the Form 982 you fill out at tax time. Also, debt forgiveness only counts towards the primary residence and some "qualifying" and some "nonqualifying" debt. Did I get all of that right?

Here's what scares me. My brother took a lot of money out of his home and paid off his credit cards, his cars, bought a pool, landscaped the house, went to Hawaii, etc, etc, etc. So basically, other than his house, he's debt free. That's good. What would be bad is if he got a tax bill for 100k next year.

Using the IRS form 982 example, suppose he took out a 1 million dollar loan to buy an 800,000 house. He used the extra money (200k) for: 50k on home improvements, 50k to pay off student loans, and the other 100k for credit cards/cars/boats/vacations. He ends up short selling the home for 700k. He'll get 1099'd for 300k of which 100k is excluded from tax due to the DFA. What about that remaining 200k? Is that all going to be taxable? Just the part that didn't go into the house? Or some amount in between?
I'm concerned because the way my brother is under the impression that he basically gets to walk away from his home without the stigma of a foreclosure and with no tax penalty. That smacks of "too good to be true" to me.

[rbolski_in_NV]

My understanding matches up to yours - supported by my personal research, discussion with tax attorney and discussion with realestate attorney. Your brother isn't going to get away clean. The lender may send a 1099. It isn't a 100% done deal. If they don't send it, feedback given to me has been to not file the debt forgiveness. Just forget about it. I am going to look into that further though. If the bank files, then you will have to break out the receipts to show where that $100K was spent. You might be able to play some games on the other $200K, but I would guess that he will have a tax liability on $100K+.

That said, I also think that there is a strong possibility of some new legislation in early 2010 forgiving some portion of that tax liability on people who went through a foreclosure or short sale. There will be a mighty up roar when tens of thousands of homeowners who went through a short sale of foreclosure are now faced with a tax liability on $20K - $700K. I would hazard a guess that 80% of these people don't even know it is coming.

The question I have not found an answer for is how long does the bank have to file the 1099. If a foreclosure or short sale occurs in 2009, does that bank have to file the 1099 and send it to you by end of January 2010 with all your other tax documents? Do they have another year? At what point do they give that right up?

[bonkers65]

Originally Posted by rbolski_in_NV

The lender may send a 1099. It isn't a 100% done deal.

This is really confusing to me. A lot of what I've read seems to suggest that a) 1099 is a given or b) it's up to the lender (i.e. if they feel like jamming you up, then they send it). This is counterintuitive to what I know of banks. I've used a lot of words to describe the banking industry but "capricious" isn't one of them. It would seem to me that the only way they wouldn't file a 1099 is if they decide to hold the homeowner liable for the difference (loan amount v SS amount). If that's the case they wouldn't really be forgiving the debt and so I could understand them not filing a 1099.

I did a little more digging and found the following in the IRS pub:
http://www.irs.gov/pub/irs-pdf/p544.pdf

The lender must file Form 1099-C and send you a copy if the amount of debt canceled is $600 or more and the lender is a financial institution, and use of the property with the intention of credit union, federal government agency, or any organization that has a significant trade or business of lending money.

That said, I also think that there is a strong possibility of some new legislation in early 2010 forgiving some portion of that tax liability on people who went through a foreclosure or short sale.

I don't know what should be higher priority: what you suggest here or getting the lenders to comply with some level of human decency when it comes to FC/SS's.

[rbolski_in_NV]

I've been told by an individual in the baking industry for 25-years that the banks will do both - deficiency and 1099. Maybe not all... but they are going after you both ways. I don't know if this is right, just what I have been told by someone with expertise here.

The 1099 is in question as even if they have the right to send it, most banks are in such disorganization that most of their workers can barely get their shoes on the right foot and get to work. How do they send out a 1099 if they can't even process a short sale for 6 - 12 months? That is why I wonder how long they have to file. I would think they have until the end of Feb like any other tax forms.

Finally, I'd go the route of decency for now... but I wouldn't hold my breath. I have been reasonable and decent and it hasn't gotten my very far. The Plan B is for your brother to cross his fingers and hope some legislation gets passed.

[KFish]

It may depend on what state he is in, but my attorney (Arizona) said the banks can't do both..come after you for the deficiency AND send the 1099. It's either - or. Also, I would imagine there is a time restriction in which the bank has to file the deficiency action lawsuit (90 days from foreclosure sale in AZ) in all states...

Hate to say it...but he should probably check with an attorney in his state that is familiar with real estate law. Costed us $500 but he reviewed 5 sets of loan docs for 3 properties...and at least now, we know exactly where we stand. I hear some attorneys will give you a free consult as well. Ours was a little bit of a mess, so I couldnt find anyone to do it for free

Good luck and keep us posted...we all learn from each other's experiences here.

[rbolski_in_NV]

Originally Posted by KFish

It may depend on what state he is in, but my attorney (Arizona) said the banks can't do both..come after you for the deficiency AND send the 1099. It's either - or. Also, I would imagine there is a time restriction in which the bank has to file the deficiency action lawsuit (90 days from foreclosure sale in AZ) in all states...

Hate to say it...but he should probably check with an attorney in his state that is familiar with real estate law. Costed us $500 but he reviewed 5 sets of loan docs for 3 properties...and at least now, we know exactly where we stand. I hear some attorneys will give you a free consult as well. Ours was a little bit of a mess, so I couldnt find anyone to do it for free

Good luck and keep us posted...we all learn from each other's experiences here.

In the State of Nevada banks have 6-months to come after you on the 1st and 6-years on the 2nd/3rd/4th...

[floridagirl23]

My Vacation Home was foreclosed on by Washington Mutual/Chase Dec 2008 and I didn't have to pay taxes on the forgiven debt. I received a tax statement from them and was quite expecting to owe something but didn't. This was in the state of Georgia.

Its probably up to the lender but not sure. Even still I don't think I would risk it just in case.

[cahomeowner]

is this your brother's primary residence? the bank can issue a 1099 OR pursue a deficiency judgment but they can't do both. also I believe they need to file that 1099 by jan or feb 2010. you will need to research the laws in your state. I would also research the IRS form 982 and talk to an accountant who specializes in real estate to ask how the form 982 can offset the 1099.

I also agree that there will be some new legislation entered to help people in this kind of situation. I would find all of this out now in turns of what he can expect. He could also file bankruptcy and surrender the property. If he did it in bankruptcy did he would not be liable for the taxes. consult a BK attorney on the best strategy.

short sale is still new so I would be interested if someone can start a thread for those folks that have already completed their short sales to see what kind of tax implications they ran into.

[bonkers65]

Originally Posted by cahomeowner

is this your brother's primary residence? the bank can issue a 1099 OR pursue a deficiency judgment but they can't do both. also I believe they need to file that 1099 by jan or feb 2010. you will need to research the laws in your state. I would also research the IRS form 982 and talk to an accountant who specializes in real estate to ask how the form 982 can offset the 1099.

He lives in Nevada and it is his primary residence. The housing market just tanked there (I'm pretty sure NV was in the top 10 of worst hit).

I think I'm going to urge him to talk to an accountant or tax attorney. I feel like he's getting fed the best case scenario from his RE agent.

[cahomeowner]

Originally Posted by bonkers65

He lives in Nevada and it is his primary residence. The housing market just tanked there (I'm pretty sure NV was in the top 10 of worst hit).

I think I'm going to urge him to talk to an accountant or tax attorney. I feel like he's getting fed the best case scenario from his RE agent.

have him consult with a bankruptcy attorney as well.