Serious tax consequences may result from either a short sale or foreclosure. As with most IRS information, it is not an exciting read, but you could save yourself thousands of dollars in taxes.
Many distressed homeowners who have left their homes or lost their home by foreclosure will receive a 1099-A, 1099-C or both from the lenders. Lenders are required to file the 1099’s with the IRS and mail a copy to the borrower. Depending on the form you receive, you could be liable for thousands of dollars in additional taxes.
What do these tax forms mean? By definition, a 1099-A is for “Acquisition or Abandonment of Real Property” and a 1099-C is for “Cancellation of Debt.” This article outlines the circumstances in which you may receive a 1099-A and/or 1099-C. If you do receive a 1099-A or 1099-C, it is important to contact your accountant or tax preparer immediately to discuss the tax consequences and any possible exemptions.
1099-A:
The lender’s responsibility to file the 1099-A is triggered when the lender acquires an interest in the property that is the security for the loan. It does not matter if the interest acquired represents a full or partial satisfaction of the debt.
A 1099-A must be filed in three (3) situations:
1. Foreclosure: Regardless of whether the lender is the first, second or third mortgage holder, upon foreclosure of the property, all lenders are required to file a 1099-A for the amount of the debt. The 1099-A is required if there is a deficiency and the lender does attempt to collect the deficiency from the borrower. The lender is required to file if they know or have reason to know the foreclosure has taken place.
2. Abandonment: If the borrower intends to, and has permanently given up possession and use of the property, the lender must file a 1099-A. If a foreclosure will be performed within three (3) months of the abandonment by the borrower, the lender may wait to file the 1099-A until the date of the foreclosure sale. If a foreclosure is not scheduled within three (3) months of the abandonment, the lender must file the 1099-A within three (3) months of the date of abandonment.
3. Claim and Delivery: Claim and delivery is a legal action to recover property, for 1099-A purposes, only property that is security for a debt. A 1099-A is required if the property is used for business, trade or investment purposes. Property solely for personal use does not trigger the requirement to file a 1099-A.
1099-C:
The lender’s responsibility to file a 1099-C is triggered when the lender acquires an interest in the property that is the security for a loan and the lender forgives, cancels or discharges the debt. Canceled debt must be reported as “gross income” and the borrower will be required to pay tax thereon unless the debt qualifies for an exclusion or exception.
1. Debt cancellation: Lenders who cancel, forgive or discharge any debt for $600.00 or more are required to file a 1099-C with the IRS.
2. Foreclosure: Regardless of whether the lender is the first, second or third mortgage holder, upon foreclosure of the property, all lenders are required to file a 1099-A. The 1099-C is required if there is a deficiency and the lender does not attempt to collect the deficiency from the borrower. If the debt is canceled, the lender need only file a 1099-C and not a 1099-A.
When a borrower receives a 1099-A or 1099-C, the IRS has already received the form. You must address the tax issues immediately. Failure to do so may result in penalties and fees.
If you have any questions regarding short sales and foreclosures, more information is available on the short sales and foreclosure page of this website. If you are tired or reading information on the internet and would like a free, in person or over the phone consultation with one of our attorneys, please contact us.
I have been trying to get a home loan modification, and have not been successful. Now I am attempting to do a short sale, but am concerned about the tax liability. The person who is selling the house ASSURES me there will be no tax liability. I am not so sure. I owe $644K on the first and $54K on the 2nd.. He is offering the home at $450 and has 2 buyers…. what does this mean to me in taxes??
Heather
Dear Heather:
You are right to be concerned, not just about tax consequences but the 2nd loan seeking a deficiency for any amount not paid in the short sale escrow. I need to know if the first and second loans are purchase money or not and where your home is located. I am a California attorney and only advise persons on California real property law.
If both your loans are “purchase money” or the original loans when you purchased your home, there are no deficiency or tax consequences after foreclosure or short sale.
If the 1st loan is purchase money and the 2nd loan a refinance, the problem is more complicated. The law is not settled as to lines of credit or non-purchase money loans on a short sale. I would insist the lenders on both the 1st and 2nd sign escrow instructions specifying that they will not seek a deficiency judgment. However, you need to consult with your accountant as to the tax issues regarding debt relief for the amount of 2nd not covered by the short sale.
Please feel free to contact me by telephone so we may explore the issues further.
H Hibbard