Bankruptcy, short sale, debt forgiveness tax and the fiscal cliff
Posted by Robert Weed / in General Information About Bankruptcy Law, Virginia Bankruptcy / 20 comments
The 2007 Mortgage Forgiveness Tax Relief Act expires December 31, 2012. That’s one of the tax cuts, put in place when George Bush was president, that are about to expire. This one may force more people to file bankruptcy.
The Mortgage Forgiveness Tax Relief Act helped people whose houses lost value during the crisis to use short sale and avoid bankruptcy. If it’s not extended, bankruptcy will be better. Because of the “fiscal cliff,” it looks likely the Act will expire.
What’s the fiscal cliff?
In August 2011, Congress and the President set December 31 2012 as the deadline for sensible plan to reduce the federal deficit. If no sensible plan can be worked out–drastic spending cuts and tax increases hit. Those drastic changes are now called the fiscal cliff. After 16 months, no sensible plan has yet gained support. There are three weeks left.
Since one of the goals of the fiscal cliff negotiations is to raise money, extending this tax break might be a hard sell.
How Did the Mortgage Forgiveness Tax Relief Act help people stay out of bankruptcy?
The reason is taxes. The general rule is that debt forgiveness is income. A short sale is income. And the income tax taxes income.
Look at it this way. Suppose you borrow $1000 from your boss. Then the boss says you don’t have to pay him back. That $1000 loan is changed into a $1000 bonus–and you owe taxes on that.
The same rule applies in a short sale. Bank of America lends you $400,000. Then they say you only have to pay back $300,000. Bank of America has given you a $100,000 “bonus”–you owe taxes on that $100,000. (About $30,000 in taxes, depending.) Unlike your boss, who might forgive a loan of $1000, Bank of America is sure to issue you a 1099-C after the short sale. So the IRS KNOWS $100,000 in debt was forgiven.
(This same problem comes up when people negotiate a settlement with their credit cards. People who don’t know about debt forgiveness tax are blindsided when they get a bill from the IRS.)
The Mortgage Forgiveness Tax Relief Act said you don’t have taxes on money forgiven in a short sale–from 2007 to 2012. That means a homeowner who got approved for a $300,000 short sale on the $400,000 mortgage could walk away clean. (The Act only applied to your residence–short sale on investment property was still taxed.) Starting January, unless the law is extended, there would be about a $30,000 tax on the short sale. Ouch!
How does bankruptcy come in?
There’s no debt forgiveness tax on debts wiped out in a bankruptcy. So one way for our homeowner to avoid a tax on that $100,000 is to file bankruptcy. Then after the bankruptcy, the homeowner can still do the short sale; of just let the bank foreclose. Either way, no debt forgiveness tax.
Are there other ways to avoid tax on a short sale?
There’s one. If you are “insolvent”–meaning hopelessly in debt–then the tax is forgiven. Your accountant can help you with that. Starting 2013, if you are looking to do a short sale, and you don’t want to do a bankruptcy, you need to talk very carefully with a CPA or other tax adviser to see if you can afford to pay, or can avoid, the tax on the debt forgiveness income.
You may also want to talk to a bankruptcy lawyer.
So glad I stumbled on your website. I filed chapter 7 two years ago. At the time I did not file a reaffirment. Not intentionally. I just did it incorrectly and it was too late for me to file. I didn’t have a lawyer. Fast forward to today. Just found out that not having the reaffirment may have actually worked in my favor.
See I am relocating and I can’t sell my house because I am about 40k upside down. So I want to give it up to the bank. I am one month behind on my mortgage. I have two questions.
1. What is the best way to give up the house, and would I still be liable for the taxes.
2. I just pulled my credit. All 3 bearues are reporting a zero balance and showing bankruptcy. Transunion and Experian stopped reporting when the bk was discharged. Experian still is showing its been reporting till today. Is this good or is it bad and do I need to dispute it. It’s showing my account in good standing. The last reported month was in September.
I look forward to hearing from you
You are one more person who is SO GLAD they didn’t reaffirm those debts.
1. There’s no tax liability for debts forgiven in bankruptcy, so you don’t need to worry about that. If you want to give up the house, stop paying. The big question is how long will it take them to foreclose after you stop. Usually about six months here in Virginia–longer most other places. Now, if there’s an hoa, make sure you keep paying that. (Your ability to get a mortgage and buy again is better if you do a shortsale, compared to just stop paying and move when they foreclose. Don’t know whether that would matter to you.)
2. It’s minor, but I think you should dispute Experian and get them to freeze the report as of the date of the BK. Bad credit counts less as it gets older. Reporting new again each month might be hurting you some.
Thank you Robert. I will be doing a short sale. My HOA is paid and upto date. So glad I did not reaffirm. I will follow up with the credit agency to correct that error
The Wall street Journal reports that the Mortgage Forgiveness Tax Relief Act was extended for one more year. http://blogs.marketwatch.com/election/2013/01/02/cliff-deal-keeps-tax-help-for-struggling-homeowners/
After my divorce, my wife and i had to short sale our home. It is to be finalized on 03/08/2013, and it is my understanding the Tax relief has been extended thru 2013. Do we recieved a 1099 from the bank and file it with the IRS for them to forgive it? Or do they automatically get a copy? In other words, do i have to do anything with the 1099 for the forgiven debt? also, if i have to file it, do i need to do it before 2014, even though this happened in 2013, am i ok to file it in 04/2014 if we have to file? Im really confused, thanks!
I’m a bankruptcy lawyer, not a tax guy. But I think you file the form with your 2013 taxes in April 2014.
We did a short sale in 2012 and just received a 1099c. The house was in my husbands name and it was a fixed Laon. We bought another house in my name as the primary but he had to put his name on it as well. We did talk to a tax advisor before doing this and we were told we would be okay. I don’ t think that is the case. I am afraid we will owe about 65,000 in taxes. Are we able to file bankruptcy on this debt? We live in Ca. I am sick about this and don’t know what to do.
I’m NOT a tax guy, but for here’s what the IRS says about that. http://www.irs.gov/Individuals/The-Mortgage-Forgiveness-Debt-Relief-Act-and-Debt-Cancellation. (This IRS link talks about it expiring at the end of 2012, but I’ve heard Fiscal Cliff deal extended it through 2013.)
The Mortgage Forgiveness Debt Relief Act and Debt Cancellation
If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.
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, qualifies for the relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.
I have not received a 1099 for the short sell of my home in June 2012. The lender says it was because I did not reaffirm my morgtage debt my bankruptcy discharged in Jan 2012. Do I need to report this on my 2012 tax return?
No you don’t. the debt was wiped out by the bankruptcy, not the short sale, so there’s no 1099-C. That’s a good thing. Not reaffirming the debt was a good thing. More about 1099’s here. https://robertweed.com/blog/general-bankruptcy-law/bankruptcy-foreclosure-1099-a-and-1099-c/
I sold my primary residence through a short sale in 2012. I did receive a 1099-C indicating that the debt was forgiven; however, the box was checked indicating that I was liable for the debt. Do I still have to pay taxes on the amount or am I covered under the Mortgage Forgiveness Debt Relief Act of 2007?
I’m a bankruptcy guy, not a tax guy. But if you meet the requirements of the Mortgage Forgiveness Debt Relief Act of 2007 you should be ok.
It’s important enough that you should show it to somebody who is a tax expert.
I short sold my home in March 2012. Should I have received a 1099-s in addition to a 1099-c?
Thanks for your question.
I’m a bankruptcy lawyer, not a tax guy…. I never heard of a 1099-s.
I looked it up on the IRS website–this is what I saw: http://www.irs.gov/uac/Form-1099-S,-Proceeds-From-Real-Estate-Transactions
On the instructions, they added this:
The following is a list of transactions that are not reportable;
however, you may choose to report them. If you do, you are
subject to the rules in these instructions.
1. Sale or exchange of a residence (including stock in a
cooperative housing corporation) for $250,000 or less if you
received an acceptable written assurance (certification) from
the seller that such residence is the principal residence
(within the meaning of section 121) of the seller and the full
amount of the gain on such sale is excludable from gross
income under section 121. If the certification includes an
assurance that the seller is married, the preceding sentence
shall be applied by substituting “$500,000” for “$250,000.” If
there are joint sellers, you must obtain a certification from
each seller (whether married or not) or file Form 1099-S for
any seller who does not make the certification. The
certification must be signed by each seller under penalties of
A sample certification format can be found in Revenue
Procedure 2007-12, 2007-4 I.R.B. 354.
I’m thinking that 1099-s comes in on sale of commercial real estate, but not principal residences, like your home. But just don’t know.
Sorry I’m just not a help on this.
i am in Chapter 13, I have a second home i surrendered, However, BOA never foreclosed and now it belongs to another servicer who now wants to modify the mortgage. We have been out of that property for three years and i was wondering how the trustee would respond to this,, we have been in 13 for over three years always on time and only have about a year and a half left in the plan. dont want to open a ” can of worms” on this.. What do you think?
Thanks for your great information.
Even if I knew your complete details it would be hard to make a suggestion. I don’t know your Chapter 13 trustee and I don’t know your judge. Around here it would be a can of worms, but some places it would not be a problem. Ten years ago it wouldn’t have been a problem here; now it is.
I had a chapter 7 bankruptcy discharged in March of 2008. At that time Chase held my first mortgage. My lawyer advised me not to reaffirm the loan. I continued to make payments anyway. In the summer of 2013 I fell behind on my payments. At that time Chase sold my mortgage to Seterus which is a servicer and a debt collector. They refused to acknowledge the bankruptcy and started calling constantly as well as reporting to the credit agencies negative information. I made a deal with them to get caught up for the two months I had fallen behind and I did catch up shortly after. Chase repeatedly told us they sent all the proper paperwork to them about the bankruptcy. Seterus still called, sent letters, and reported that I was late even when I caught up. I have less than four payments left on my mortgage and they are still reporting wrong information. I reached out to them to tell them to change the reports but they refused. They are keeping me from being able to refinance my home to pay off my second home equity loan which would clear up my balances. Can I sue Seterus for loosing my home as a result of their neglegent actions for the value of the home, the discharge violations and the stress they are causing me? Thank you for your time.
You need to talk to a lawyer who does Fair Credit Reporting Law and Fair Debt Collection Practices law in your area. Here’s a good place to look. http://www.consumeradvocates.org/find-an-attorney. I thnk they will be really interested to talk to you.
I don’t know if you can help me or not since this thread is so old, but I sold my home in a short sale in sept 2021. I received a 1099-C. We filed for chapter 7 bankruptcy in 2016 and never reaffirmed the debt. I usually do my own taxes on turbo tax. Do I need to enter this 1099-C somewhere even though we didn’t reaffirm that debt?
I’m not enough of a tax guy to answer that question. Sorry.