If someone goes into foreclosure or “short sale”, they will have their mortgage debt reduced or eliminated. Thousands of Tampa Bay homeowners have successfully completed “short sales” this year. A short sale occurs when a negotiation is entered into with lender to accept less than the full balance of the when a home is sold; and the lender usually pays the closing costs, commissions and any liens. The negotiation occurs after a purchase contract and all required documentation is presented to the lender. If you sold you home with a short sale, then you need to be aware of IRS filing requirements.
Consult your CPA for more details, but the bottom line is: most Tampa homeowners will not owe tax on the forgiven amount. Prior to the Mortgage Forgiveness Debt Relief Act (HR3648), homeowners of primary residences were subject to a “Phantom Tax” on whereby the amount forgiven would count as income. Since the passage of this retroactive law in December 2008, eligible homeowners still report the cancelled debt as income, but they also are granted exclusion to write off the income. The new write off only applies to forgiven debt on primary residences and cancelled debt up to $2,000,000. If you acquired a home equity line of credit (HELOC) after closing that was not used to improve the property, then forgiveness of that loan may be subject to tax.
Report the Income: Form 1099-C
If you had mortgage debt reduced of forgiven, you can expect the lender to send a Form 1099-C: Cancellation of Debt. On the Form 1099-C, box 2, you will see the amount of forgiven or canceled debt. When you receive Form 1099-C, you should immediately verify that all the data is correct. Verify your personal information, and the Amount of Debt Forgiven (BOX 2), and the “Value Listed for the Home” (BOX 7). Notify the lender if any of the information is incorrect. Even if the lender did not send you the 1099-C, you are still responsible to report the income.
Report the Exemption: Form 982
In order to write off this income (forgiven debt), the debt must qualify. The debt must have been used to buy, build or substantially improve the taxpayer’s principal residence and must have been secured by that residence. In other words, home equity lines of credit that were used to pay for non-home improvement items do not qualify. Debt used to refinance a principle residence is eligible, but only up to the old mortgage principle (just before refinancing). The forgiven debt must be reported on Form 982 – Reduction of Tax Attributes Due to Discharge of Indebtedness; and Section 1082 Basis adjustment.
These issues are complex, replete with exceptions and full of caveats. Please consult a qualified tax professional for details.
- By Dale Bohannon
