1099-C short sale and foreclosure income may not be taxable…a CPA helps minimize 1040 income taxes
Did you know that if you owed money to someone else and they canceled or forgave the debt, the difference is treated as income for tax purposes and you may have to pay tax on the amount forgiven.
Sounds like a cruel hoax, doesn’t it? Perhaps, you fell behind in your mortgage payments and lost a property in foreclosure. Maybe your lender approved your short sale because the market value of your home was less than the amount owed and you needed to find work elsewhere. Unfortunately, under these scenarios, you now have forgiven debt that is considered by the IRS as 1099-C Cancelation of Debt (COD) windfall income—even through you didn’t see a penny in your pocket!
The news is not all bad, but you need to know your options. While the tax laws and exceptions are complex and confusing, below is some basic information that you should know when talking to your tax preparer. Even well meaning, but uninformed, tax preparers could cost you a lot of money in unnecessary income taxes, if they don’t ask the right questions.
IMPORTANT points and definitions related to 1099-C income
Canceled Debt: Any debt for which you were personally liable that is canceled or forgiven by the lender.
Discounts and Loan Modifications: Changes to the terms of a current loan agreement by the lender. These changes could be a reduction in the original amount owed or even a special discount for paying off a loan early.
Generally, both canceled debt and loan modifications result in 1099-C taxable income. However, there are exclusions. If an exclusion applies to your situation, you can avoid paying tax on the debt cancelation. The exclusions include:
- Qualified Principal Residence Indebtedness – Debt canceled on your “main” home is not included in your income if you are married and the amount of canceled debt is less than $2,000,000.
- Property used in a trade or business – You can elect to exclude canceled qualified real business indebtedness from income, if the real property was used in a trade or business.
- Insolvency – Do not include a canceled debt in income to the extent that your liabilities owed were larger than your assets immediately before the cancelation.
- Bankruptcy – Debt canceled in a bankruptcy case is not included in your income.
Preparing a tax return with 1099-C income can be challenging—and reporting exclusions even more difficult. Make sure you understand the facts of your transaction and don’t risk filing your 2009 income tax return incorrectly.