1099 on short sale and foreclosure

[emaretta]

Ok, I am reallllllly confused about this 1099 thing...
I was going to try to short sell my rental property to protect my tenants from the bank, but understand that I will get a 1099 from the mortgage company for the difference of my short sale and mortgage.
Am I going to be slapped with a huge tax bill after I'm discharged because of my short sale? And if I short sell after filing, will the 1099 tax liability be included in the bankruptcy?

Details: I just missed my 3rd payment 10/1 on the rental and was sent the "official" letter of intent to foreclose. I called the mortgage company and agreed to make 1 payment by the 19th, but I don't think I want to pay them any more money so I can save for my attorney fee so I can file this month.

[HHM]

There are only 2 ways I know of to avoid the tax on a short sell of real estate.

(1) if at the time of the short sale, you were insolvent. You will want to look at IRS Form 982 (however, cancelled debt in excess of $600 is reported, by the taxpayer, on form 1090C). If you are insolvent by IRS standards, you do not pay income tax on forgiven debt.

(2) If you let the house foreclose "before" or "during" a BK. Granted, a foreclosure is not a short sale, but the BK wipes out any deficiency balance as an unsecured debt and thereby you will not have any income tax liability on that deficiency.

Since cancelled debt is considered "income tax" you cannot discharge the tax in BK because the tax is too new (unless, of course, you wait 3 years to file BK).

It doesn't matter when you do the short sale, before, during (although it is unlikely you will be allowed to short sell during the BK for numerous reason, i.e. automatic stay, the trustee, etc, but it is possible), or after BK. The bank is forgiving debt and the Sale is considered a taxable transaction by the IRS, and therefore you will get 1099'ed on the difference between what is owed and what is paid to the bank. (assuming that amount is over $600).

If your facing BK, odds are, you WILL qualify as insolvent and therefore will not have to pay the income tax on the forgiven debt.

[emaretta]

Thanks HHM!
I did some more research and it seems that an exemption for the 1099-c to NOT be counted as an income source is bankruptcy...so I should be fine. I'm waiting to hear back from my atty for confirmation of this. It looks like the trustee will file the request with the IRS for the 1099-c to be exempt due to the bankrupty.

[HHM]

What happens is, the BK creates the insolvency situation. It's not that the debt is discharged, it's just that the BK makes you, by default, insolvent and therefore not liable for the income tax. Keep in mind, if you short sell "before" the BK, there is no debt to discharge because the bank has already "forgiven" the debt. If you short sell inside the BK (assuming the trustee lets you), the situation gets a little murkier...but bottom line, the bank still has to agree to release the lien on the home in order to transfer clear title, and therefore they must accept the short sale.

In any event, that is merely mechanics of "how" it works, which you really don't need to know.

[Boscoe]

This subject seems to come up alot.

Bottom line is this:

Debt cancelled/discharged by a bk is NOT taxable. Period. It makes no difference of when it occurs.

Please let us all know if there is a tax accountant and/or CPA out there that can dispute what I say above.

This is yet another good reason to file, rather than hoping for a short sale or some other miracle, especially in this terrible market.

[SinkingFast]

We got a last minute offer on our house that saved us from Foreclosure. We hoped that would help with our getting another mortgage down the road. BUT, our Credit Reports show the 150 days late. Mortgage pros that post here say we didn't really do ourselves any favor.

Generally speaking, when you get to the 120-180 days late stage, prospective Creditors are gonna consider it a Foreclosure anyway. Regardless of whether you actually sold or not.

Since you're already at the 90 days Late and counting stage, you probably won't save any face if you do Short Sell. Even if the property gets sold inside BK.

Just something for you to consider. Might save you some heart ache and frustration.

[emaretta]

Thanks for all your replies...

The only reason I'm considering short sale on the rental is to protect my tenant's lease. They don't want to move and are unaware of my situation. I figured I'd have better luck selling to a private investor who will honor their lease instead of letting the bank have it and them being kicked out unexpectidely in a few months right in the middle of the school year.

[dscurlock]

Thanks for all your replies...

The only reason I'm considering short sale on the rental is to protect my tenant's lease. They don't want to move and are unaware of my situation. I figured I'd have better luck selling to a private investor who will honor their lease instead of letting the bank have it and them being kicked out unexpectidely in a few months right in the middle of the school year.

i also have tenants in my house, I called a mortg broker today, he has called
10 lenders so far, and all of them have declined to refinance my 80/20 loan.
he also said, even if they did, it would be considered an investment property,
I would get even high payments then what i have now...im barely paying
the mortg now with the tenants rent...

i do not understand, even with your short sale, why would you get a 1099??
you are not actually getting or making any money, the bank is, and you get the difference
that you would owe...if your house was $100k, and you sold it for $150, I could
understand, but if you owe $100k, and you sold it for $80k which is -$20k

so i do not understand why a 1099 would be used, you are losing money,
not making any off of the home.

[HHM]

i also have tenants in my house, I called a mortg broker today, he has called
10 lenders so far, and all of them have declined to refinance my 80/20 loan.
he also said, even if they did, it would be considered an investment property,
I would get even high payments then what i have now...im barely paying
the mortg now with the tenants rent...

i do not understand, even with your short sale, why would you get a 1099??
you are not actually getting or making any money, the bank is, and you get the difference
that you would owe...if your house was $100k, and you sold it for $150, I could
understand, but if you owe $100k, and you sold it for $80k which is -$20k

so i do not understand why a 1099 would be used, you are losing money,
not making any off of the home.

This is a bit of an over-simplification...but here goes...

Look at it this way, YOU have NOT lost money, you LOST THE BANKS MONEY because the bank loaned you the money to buy the house. From the IRS's perspective, if person "L" lends you money, they give you a check. You, person "B", spend that money on something "P". If you cannot payback "L", and "L" decides to forgive that debt, it was "as if" "L" simply wrote you a check...thus, from IRS perspective, that is INCOME.

Note there is difference between you losing money on money you invested, and money you borrowed to invest.

For example...If you purchased a house for $100k and paid cash, and were only able to sell 3 years later for $80K, that would be YOUR loss. If that house was your primary residence, you would take that as a capital loss, if it was an investment property, it would be a business loss. However, if your "borrowed" that $100K to purchase the house and then 3 years later you were only able to sell the house for $80K, YOU have NOT actually lost anything, you lost the bank's money. If the bank agrees to accept less than what you owe, in essence, the bank has given you $20K, and the IRS treats that as income.

In any event, bottom line, the IRS treats ANY forgiven debt as income and expects you to pay income tax unless you were insolvent (IRS form 982), the amount of forgiven debt is $600 or less, or the debt in question is discharged in BK.

[emaretta]

Correct HHM. I even learned that all of the discharged debts in bankruptcy create 1099-c's, but they are washed away b/c of the bankruptcy so you never see them but they're technically there.

[HHM]

Correct HHM. I even learned that all of the discharged debts in bankruptcy create 1099-c's, but they are washed away b/c of the bankruptcy so you never see them but they're technically there.

Correct...it even goes one step further. The 1099-C's on debts that are discharged are actually issued to the BK Estate and sent to your BK trustee...and it is the BK trustee that files a tax return on behalf of the BK estate.

Most people don't realize that the Trustee, in ALL CASES, files a tax return on behalf of the debtor's BK Estate.

[wfjd6030]

I just got confirmation our a plan that my husband and I have to agree on. We haven't made our decision yet. BUT...we intend to give up the house shortly. So based on the dialogue here, you're saying that by being bankrupt, I will be protected or excempt from paying the forgiven debt on the difference of the purchase price of my home and the amount it will end up getting auctioned of for?

[lostinmich]

I have a similar situation in regards to some rental property. Here's a link that was provided to me. It helps explain the rules and it comes directly from the IRS.

http://www.irs.gov/newsroom/article/0,,id=174022,00.html