Bankruptcy related to foreclosure and short sales and tax consequences

As an insolvency lawyer, I meet people every day who are in very unfortunate situations. During the recent tough financial times, many people have faced foreclosures or short sales of their homes.

Some people are just happy to have the opportunity to get out of a loan/debt that has been weighing them down. Some people had a robbery loan that had turned into a monthly payment that was no longer affordable or realistic. Whatever the reason, many of these people were faced with a big surprise that their real estate agent or broker never told them about:

Tax consequences!

Nobody likes to pay the IRS every year. But it can be even more painful when your mortgage company hits you with a 1099 for hundreds of thousands of dollars!!

How does this happen? Simply put, let’s say your home sells short for $500,000.00, but your mortgage was for $750,000.00. The mortgage company suffered a loss of $250,000.00 on this arrangement and can recover that loss from the government at tax time. lenders are necessary according to tax law, to send a 1099 to all borrowers in this situation. So if you have that debt forgiven, that will be considered income for the IRS. So now you have to pay income tax on that $250,000.00!!!

How can someone who can’t pay their mortgage find a way to pay income on such large amounts? Well, they usually can’t. Fortunately, in 2007 the legislature recognized this and passed what is known as The Mortgage Forgiveness Debt Relief Act and Debt Cancellation. This gives borrowers a chance to be exempt from paying those debts as long as they were forgiven between 2007 and 2012. The form used is called Form 982 and must be attached to your tax return. This form can be downloaded here: Form 982. Just scroll to the bottom of the page and download it as a free PDF.