Reducing the Tax Burden
Chances are that if a homeowner has had their home foreclosed on it is likely they were in a difficult financial position. In some cases, tax burdens are just an added issue that homeowners have to face. However, there is some good news about this, at least for homeowners who are facing foreclosures and potential tax liabilities.
What cannot be included on a 1099-C
Lender are not allowed to include any interest, late fees or collection fees associated with foreclosure debt on a form 1099-C. These amounts are not considered part of the original debt.
If a home sold for less than the fair market value, the homeowner who lost their home to foreclosure may not be in such dire straits. Lenders must take the fair market value of the property and use that as the basis for the 1099-C. If the amount owed by the homeowner is more than the fair market value, the difference can be filed via 1099-C.
IRS Form 982
Form 982 is designed for homeowners who are theoretically insolvent. This means that the amount of money that is owed is greater than the total sum of their assets. While some homeowners will file for Chapter 7 Bankruptcy as a means of restructuring their debt, they do not have to do this in order to use Form 982. This form is filled out and filed along with the homeowner's taxes and may allow them to not have to pay taxes on 1099-C income.
The Mortgage Debt Relief Act of 2007
As a result of the number of homes that were foreclosed on, the Mortgage Debit Relief act was passed. According to the IRS website this act is defined as "The Mortgage Debt Relief Act of 2007", and 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."
Most homeowners will qualify for this relief. It is critical that homeowners who are facing potential tax liability from a foreclosure sale talk to their tax accountant for advice regarding potential waivers of tax liability.