Do you know about the 1099-C and cancellation of debt?

When a home owner sells his or her property using a short sale a 1099-C is generated.The IRS issued a news release on Sept 17, 2007 trying to clarify the 1099-C in regards to foreclosures. Many homeowners are unaware of this situation and feel once the property is gone all financial obligations are wiped out. That may or not be a correct assumption.

This will illustrate how the IRS determines your potential liability in a short sale or a foreclosure.

How to figure cancellation of debt income

1. Enter the total amount of the debt canceled/forgiven. ____________________

2. Enter the fair market value of the property from Form 1099-C, box 7. ____________________

3. Subtract line 2 from line 1. If less than zero, enter zero. ____________________

Keep in mind that #1 will differ between a foreclosure and a short sale. The short sale amount is the amount the lender has agreed to forgive from the sale of your home prior to being foreclosed on and sold at auction or thereafter. If #3 is zero or less than zero than there is not a taxable amount.

If we take a look at particular numbers for an example. Let's say Mr. and Mrs. John Q. Homeowner, owed $300,000 on their mortgage balance and the lender agreed to a short sale of $250,000, the forgiven amount is $50,000 not $300,000, the fair market value of the property is $360,000. If you enter the numbers above you'll see that #3 is a negative number being less than zero therefore, not a taxable amount. Now, if you look at this example without having sold via a short sale than you would have a taxable amount as the debt canceled/forgiven would have been $300,000 subtract the FMV of $360,000 and that leaves $60,000 in taxable income.

Amazingly what is so critical is in how the lender reports on the 1099C. The IRS is urging borrowers to look closely at the amount of debt forgiven and what value is listed for their home. If a 1099C is received from the lender and it is in error, the homeowner must contact their lender for corrections. It is important to review the 1099C to determine accuracy.

If you are not diligent it may cost you money!

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