Is your 1099-C short sale or foreclosure income taxable?

Short sales and foreclosures were all too common in Southwest Florida in 2009. So many people have been affected. They’ve lost homes and had to downsize their expectations and dreams.

Those who lost jobs may have fallen behind in their mortgage payments, prompting their lenders to take action. Others sold a home through a bank approved short sale because the market value of their property had dropped below the amount owed. The credit markets collapsed in late 2008 and many lenders turned a deaf ear to mortgagees who tried to refinance their loans and stay in their homes, while others more fortunate were able to get a loan modification to be able to stay in their homes.

The arrival of 2010 meant a glad farewell to 2009. It was time to start over. People have been forced to reimagine their future. Some of the more fortunate have found new jobs elsewhere and left the area to start rebuilding their lives. Others had fewer choices, and charitable organizations have struggled under an avalanche of those who for the first time found themselves in need of food, clothing, and shelter.

Those who were foreclosed upon or sold property in a short sale are now opening their mailboxes to find 1099-C forms from their former mortgage companies.

The IRS considers canceled or forgiven debt as “windfall income,” even though the homeowner didn’t see a penny in their pockets. For some, the news is grim —they’ll have to pay what could be thousands of dollars in 2009 taxes on the debt forgiven. For many, however, there is likely an exclusion that will result in no taxes being owed on the forgiven debt.

Local CPAs such as Mike and Tom Briers of BriersCPA are trying to help those just receiving their 1099-C forms to determine on which side of the tax line they will fall. They just launched a new Web site at www.BriersCPA.info to offer helpful guidelines to know how to proceed. “The news is not all bad,” said Mike Briers. “But tax filers need to know their options.”

While the tax laws and exceptions are complex and confusing, BriersCPA provides some basic information that tax filers should know when talking to their tax preparers. Even well meaning, but uninformed, tax preparers could cost filers lot of money in unnecessary income taxes if they don’t ask the right questions.

Generally, canceled or forgiven debt or a loan modification (change to the terms of a loan) will result in 1099-C taxable income. However, there are very specific exclusions. Generally, if an exclusion applies to the situation, the tax filer will not owe income taxes on the canceled debt.

The most common exclusion is for a home that was a primary residence. If the loan was to buy, build or substantially improve a principal residence, and the canceled debt was less than $2 million for married filers, they will qualify for the exclusion and will not be taxed on the forgiven debt. However, those who experienced a short sale, loan modification or foreclosure on a second home or investment property are not exempted under this provision and will be taxed on the cancelation of debt provisions, unless another exclusion applies.

Perhaps you were deemed insolvent. If the liabilities you owed were larger than your assets immediately before the cancelation of debt occurred, you do not need to include the 1099-C income in your reportable income.

Many Southwest Florida property owners were forced to declare bankruptcy. Debt canceled in a bankruptcy case is also not included in taxable income.

Preparing a tax return with 1099-C income can be challenging—and reporting exclusions even more difficult. It is wise to consult with a CPA to be sure you get good advice when filing your taxes. Be certain your tax preparer is especially knowledgeable in the nuances of 1099-C income, or you could end up paying too much in income taxes. Most importantly, it is essential that you understand the facts of your individual transaction to avoid filing your 2009 income tax return incorrectly. Getting bad advice or trying to file your own taxes could result in paying more than you are legally liable for paying. 