Foreclosure and short sale: what are the consequences to be aware of on your tax return?

The housing market landed on a thud in 2009 and the US saw a rapid rise in foreclosures, which in turn led many financial lenders to take to the streets. An unsuccessful stabilization was attempted by the Government. Their goal was to provide money to mortgage finance institutions and not to homeowners. In most cases, taxpayers will receive a tax form, known as a 1099-C, if they have had to go through the process of a short sale or an actual foreclosure. Due to these cases, the financial mortgage lender is in charge of providing these 1099-C tax forms and, in turn, will not seek a judgment deficiency. This was said to be great news. With this method, the amount of debt that is written off is shown as income. Note that there are always exceptions to the rule.

Below are some of the exceptions to the rules that you will encounter.

Exception A – If you have had a foreclosure on your home, box # 2 on your 1099-C will have this amount written as a forgiven debt. In common circumstances, during your home short sale by local authorities, the financial mortgage lender will buy your home from you and then it will become what is known as REO, also known as Real Estate Property. The main intention of the financial lender is to resell the house in the shortest possible time; however, in some cases, this could take literally months. There is a light at the end of the tunnel, however, the amount of the canceled debt will be made for the fair market value of the house, which you can locate in box # 7 of your 1099-C tax form. This is an essential aspect, since the difference between the loan amount and the Fair Market Value is the amount that you should be concerned about and this amount will be shown in box # 2. Please note that if this is your primary place of residence , The Mortgage Debt Relief Act of 2007, states that the amount of canceled debt is not placed as income to you.

Exception B – If you have had a short sale of your home, this technically means that your home was sold with the authorization of your financial lender at a discounted rate. For the short sale, you will still receive a 1099-C tax form. When calculating your canceled debt, they will use the actual price that you bought your home for. Note that if this is your primary place of residence, the Mortgage Debt Relief Act of 2007 states that the amount of canceled debt is not placed as income for you and you must prepare a 982 tax form.

Exception C – If your canceled debt is a rental property or other type of business debt, the loss of the property will be recorded as a sale. In this case, you will be allowed to calculate the profit or loss. To make sure this is done correctly, it is recommended that you hire an experienced professional to help you deal with debt cancellation.

Exception D – Debt cancellation income will be excluded from an insolvent buyer to the extent that the liability exceeds the Fair Market Value of all assets. In other words, if you have a pro-debt debt / asset ratio, you have to choose to omit a specific amount from your income amount. EXAMPLE: If you have a canceled debt in the amount of $ 100,000.00, and you have $ 180,000.00 in liabilities and $ 150,000.00 in assets, you can absolve $ 30,000.00. This would leave you reporting $ 70,000.00 instead of $ 100,000.00.

Exception E – This is extremely essential! In some cases, if you are married and both names are on the property deed, you can obtain two 1099-C tax forms and be able to write off the full amount of the debt. This replaces a form in the name of both people in writing. This would be an essential conversation to have with your tax professional. You never want the quantity in box 2 to be reported twice on the form.

Exception F – The income derived from the cancellation of a debt will be completely excluded after the liquidation of a bankruptcy.

The details above can help you understand the ins and outs of short sales and foreclosures and the effect they have on your taxes. Knowing the consequences early on helps avoid going blind in the future.

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