In recent years, the number of foreclosures has skyrocketed and short sales have become an increasingly popular trend. Many consumers have wondered how lenders recuperate the money lost from a mortgage after a discounted short sale. These unpaid charges are not a major concern for the lender, but the tax ramifications of a short sale or foreclosure can be devastating to the consumer.
Debt cancellation laws and guidelines require that taxes are paid on foreclosed homes, even on short sales, and this tax is often never disclosed until a form 1099C is received. Most homeowners who have undergone foreclosure can not afford this unexpected, and often rather large, tax bill. As a result, the number of tax defaults is increasing just as steadily as the rate of foreclosures.
Understanding the 1099C is vital in real estate investing and there are a few key points that every real estate investor must understand.
A mortgage with no recourse means that if the loan defaults, the only action the lender can take is to take possession of the property that was financed. As an investor, it is important to know beforehand if the loan you are working with is recourse or non-recourse. You should also determine whether or not the foreclosure is considered judicial and if the home is eligible for primary residence status. Understanding the conditions of the loan can help consumers know what taxes may be due after the process.
There are certain conditions that are exempt from debt liability under the 1099C. If the homeowner suffered bankruptcy at the time of the foreclosure or short sale or if the debt was released through insolvency, the forgiven debt is excluded from the 1099C. Farm debt and non-recourse loans, which includes the majority of mortgages, are exclusions as well.
It is also important to become knowledgeable about new and current laws and policies that may affect foreclosures, short sales, and other mortgage alterations. New legislation recently put forward by Congress will greatly assist homeowners facing foreclosure, but there are several regulations controlling eligibility for this aid. The program is restricted to homeowners principal residence and there are also restrictions regarding property used commercially at any time.
While most mortgages are loans without recourse, meaning the lender can only take back ownership of the property and not pursue the owner personally, many lenders will still submit a 1099C. Non-recourse loans are exempt from the debt cancellation tax but, in most cases, the homeowner must defend their exempt status and notify the bank. Unfortunately, most homeowners are unaware of these exclusions and can not protect themselves.
As a real estate investor, you most likely work closely with the banks to avoid any further actions against your customers seeking short sales. It is important to also remember to discuss 1099C exemptions regarding non-recourse loans with the bank as well, whenever applicable. Most primary residence mortgages fall into the category of non-judicial, non-recourse loans, so, in most instances, the only way a lender can satisfy the unpaid debt is through foreclosure and no other actions can be taken. Taking the extra time to discuss these facts with your customers can make a world of difference in their lives.
Investment properties, second residences, and other homes that do not qualify as the principal residence are affected differently by the 1099C. Those will be covered in a separate article.
