No deficiency...no problem?

Once a short sale has been successfully negotiated and you have the appropriate language in your short sale acceptance letter from your lender indicating that they will not pursue a deficiency, you're in the clear, right?

Not so fast!

What normally comes next is a 1099 C forgiveness of debt. This is now income to you in the year the debt was written off. WHAT? You bet. A creditor is required by law to issue a 1009 C to any individual who settles a debt or has a debt written off that is in excess of $600. This is a very big trap that people with lots of debt find themselves in. If you have received one of those in the mail, you may have to declare the amount on that form as income. (see your tax person) Then you will have to (maybe) pay tax on it.

Using a debt management firm to settle your debts? You settle your $5000 credit card bill for $3000. Don’t be surprised when the 1099 C comes in the mail. House sells at foreclosure sale, the bank has not been paid all the money. You should be on the look out for a 1099 C.

There are 2 exceptions to the 1099 C rule for most debt. The first applies when you are insolvent as the time the debt is written off. This is defined by the IRS. The second is if you file bankruptcy before the debt is written off and the 1099Cc is issued, there is no income to declare. If you file bankruptcy after the 1099 C is issued you still have to declare that as income. (again, check with your tax preparer). Here is a debt insolvency worksheet that you may find helpful. Also, the IRS’s website has examples to help you determine if you can qualify for this exception.

There is a third exception that is only good for real estate. It is the The Mortgage Forgiveness Debt Relief Act and Debt Cancellation. It applies to the owners of residential real estate only under specific circumstances. The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure also qualifies for the relief.



as always, the above is not intended to be legal or tax advice...consult the appropriate professionals for details regarding how this affects you, specifically.