Short Sale Debt Forgiveness and 1099-C tax liability explained

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Foreclosure-Short-Sale-Tax-ConsequencesEveryone here at Coastal REO Solutions of Myrtle Beach, SC would like to extend our best wishes to you in the New Year. The New Year always brings our thoughts around to the dreaded income tax season. Time to go through your desk drawers and shoe boxes to find those receipts and deductions. If you have been foreclosed on or done a short sale in 2010, the 1099-C Cancellation of Debt is one of the most important pieces of paper that you need to find.

A short sale is when a mortgage lender agrees to accept less money than is owed by a home mortgage borrower. The recent economic downturn has left many Myrtle Beach homeowners underwater, which is owing more money on a house that it is worth. This has caused a steep increase in the number of short sales and foreclosures in Myrtle Beach and the Grand Strand. Many homeowners who file their own taxes may be unaware of their 1099-C tax implications from doing a short sale where a portion of their mortgage balance has been forgiven by their lender.

If you have been involved in a short sale or foreclosure action this past year, we have some essential information for you about your potential 1099-C tax liabilities. This will also apply if you are thinking of accepting a short sale where the lender will waive the difference between your mortgage loan amount and the amount the home is sold for, called your “deficiency balance,” and writes off your debt as a business loss.

When someone loans you money and then tells you that you don’t have to pay it back, the IRS considers that “windfall income” that you have earned. Here is an example:

A person buys a $300,000 home with no money down by taking out a $300,000 mortgage. Let’s say the buyer can’t make the mortgage payments and the bank forecloses on the loan, accepts a short sale, takes the home back via a deed in lieu of foreclosure and waives the deficiency balance.

After one of these procedures, the lender sells the home for or NETS $200,000 after the short sale. This leaves an unpaid mortgage balance, or deficiency balance, of $100,000.  The bank or lender will “write off” this amount as a business loss on their taxes and issue a 1099-C Cancellation of Debt form to the person for $100,000.

When you have a short sale or foreclosure, an IRS Form 1099-C Cancellation of Debt will be issued from your lender if they have forgiven more than $600 of mortgage debt. In the eyes of the IRS, loan forgiveness is considered income. This means you must claim the amount on this form as income along with your usual W-2 forms from your employer. If you receive this form from your lender, then they have also sent one to the IRS. If you know you have had more than $600 of debt forgiven, but haven’t received this form, then you should call your lender immediately.

Forgetting to add this “income” could result in harsh penalties, fees and even an audit from the IRS. This is a bit of a double whammy for Myrtle Beach property owners that are already in a difficult financial situation and have lost their home to foreclosure or short sale. The good news is that there are special stipulations that can help you in this situation. The Mortgage Debt Relief Act of 2007 passed by President Bush spells out these special rules. These exceptions apply to up to $2 million in homeowner debt forgiveness. Normally, if an exclusion applies, the tax filer will not owe income taxes on the canceled short sale or mortgage debt.

If you were insolvent, meaning your liabilities are more than your assets, you may not have to pay back the debt. Bankruptcy is another special case where you would be exempt from claiming the 1099-C amount. Most Myrtle Beach primary homeowners will fall under the “qualified principal residence” clause. If your foreclosed home were where you lived the majority of the time, then it would be considered your principal residence. If your short sale or foreclosed home has been your principal residence for two years or more, then you wouldn’t have to pay taxes on the 1099-C income.

A problem some Myrtle Beach short sale actions might come up against is the “Second Home” provision. Myrtle Beach and The Grand Strand is a magnificent place to own a vacation home, or “Second Home”. However, with tight economic times, layoffs and shrinking home values, it’s understandable that someone might choose to let their vacation property go into foreclosure, or short sale a second home rather than lose their primary residence.

Many Myrtle Beach short sales have also happened in the investment property market. Speculators have bought up thousands of homes in Myrtle Beach during the good times, and now find that they must short sale the property or face foreclosure. Even commercial real estate foreclosures are on the rise as the investment market trends downward. These properties may be eligible for the 1099-C income exclusions depending on your current financial situation. This is where careful planning with Coastal Solutions and your tax preparer is crucial.

Preparing a tax return with 1099-C income from a short sale or foreclosure will be challenging, and reporting exclusions could be even more problematic. At Coastal REO, we think it would be wise to consult with a CPA to be certain you get good information when filing your taxes. Be positive your tax preparer is specifically educated in the rules of 1099-C short sale income, or you might end up paying too much or too little in income taxes. More importantly, it is vital that you know the facts of your individual short sale transaction to avoid any potential problems. We hope this article has been some help in your understanding, but please consult a tax professional if you have any questions at all.

Coastal REO Solutions is one of Myrtle Beach’s most experienced and qualified short sale real estate firms. If you need help, we are ready to assist you by talking with your mortgage lender for you. Coastal Solutions is a full service real estate brokerage firm and we can assist you through the entire process, from marketing and sales, all the way to the closing table.

Contact Jason Ellis at Coastal REO today to get started.

If you are a first time homebuyer or savvy real estate investor looking to buy a Myrtle Beach short sale or foreclosure, Coastal REO Solutions has a custom short sale search engine that is free to use.

One Response to “Short Sale Debt Forgiveness and 1099-C tax liability explained”

  1. [...] short sale and having a packet with these papers in it will speed the process along. Remember, the income tax break for a short sale ends this year and the short sale process takes [...]

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608 16th Avenue N. Suite E
Myrtle Beach, SC 29577

Phone: 843.839.8046
Fax: 843.839.9406 info@CoastalREOsolutions.com