Bankruptcy As it Relates to Foreclosure and Short Sales and Tax Consequences

As a bankruptcy attorney I meet people everyday that are in very unfortunate situations. During the recent difficult financial times many people have been faced with foreclosure or short sales of their homes.

Some people are just happy to have the opportunity to get out from a loan/debt that was weighing heavily on them. Some people were in a predatory loan that had adjusted into a monthly payment that was no longer affordable or realistic. Whatever the reason may be many of these people faced 1 big surprise that their real estate agent or broker never advised them of:

Tax consequences!

No one enjoys paying the IRS each year. But it can be even more painful when you get hit with a 1099 from your mortgage company for hundreds of thousands of dollars!!

How does this happen? Well simply put: Lets say your house sells in a short sale for $500,000.00 but your mortgage was for $750,000.00. The mortgage company has taken a $250,000.00 loss on that agreement and can claim that loss to the government come tax time. Lenders are required by tax law to send a 1099 to all borrowers in this situation. Thus, when that debt was forgiven for you, it is viewed as income to the IRS. So now you have to pay income tax on that $250,000.00!!!

How can someone who can not pay their mortgage find a way to pay income on such large amounts? Well, usually they can’t. Luckily legislature in 2007 realized this and passed what is called the The Mortgage Forgiveness Debt Relief Act and Debt Cancellation. This gives borrowers a method to be excused from paying on that debt so long as it was forgive between 2007-2012. The form used is called Form 982 and must be attached to your tax return. That form can be downloaded here: Form 982. Simply scroll to the bottom of the page and download as a free PDF.