1099 for forclosures and loss anyone heared of this?

JOCCO · Sep 25, 2010

Local guy got forclosed on, owed say $100,000 property sold for $60,000 (just example figures) Bank issued him 1099 for 40 grand. They wrote it off he is getting nailed for the 40 by IRS. Have also heard rumors of other outfits doing this, car dealers and building contractors. I
may not have the details 100% any one know what this procedure is?

Georgetown · Sep 25, 2010

I suppose any amount of a debt that is forgiven could be considered income because it's financial gain even if you didn't put any dollars in your pocket.

I'd high tail it to a good tax attorney.

Paul in MN · Sep 25, 2010

I know this is what the tax law used to require. But....during the past 2 years I think there was a change created by the current administration that effectively eliminated this tax on homeowner homestead forclosures. The 1099 may be just a reporting necessity the bank has to do. As I have not had to deal with this problem, I am not knowledgible of the details. A good tax attorney should be consulted (not the temp just hired down at the H & R Block storefront).

Paul in MN

C.R. · Sep 25, 2010

couldnt you deduct the equity that you lost through the forclosure?

David K · Sep 25, 2010

Yes I have heard of this business practice and it makes perfect sense to me. John Doe goes to the bank and borrows $200,000 to buy a farm. The bank loans him the money and he is now $200,000 (or one farm richer). He begins repaying the loan but with $100,000 still owed he stops paying. The bank is hung out for $100.000. They foreclose on the farm in an effort to recuperate some or all of their money. They recover $60,000 but they are still $40.000 in the hole. If they "write it off" John still has $40,000 of the banks money. Through foreclosure his debt is forgiven and he walks away with the $40,000. In the eyes of the IRS that money is income to be treated like any other earnings. Therefore, the bank is required to issue a 1099 so John can be taxed properly. Kind'a sucks but its the law!

David K · Sep 25, 2010

Yes, I have heard of this business practice and it makes perfect sense to me. John Doe goes to the bank and borrows $200,000 to buy a farm. The bank loans him the money and he is now $200,000 (or one farm richer). He begins repaying the loan but, with $100,000 still owed, he stops paying. The bank is hung out for $100.000. They foreclose on the farm in an effort to recuperate some or all of their money. They recover $60,000 but they are still $40.000 in the hole. If they "write it off" John still has $40,000 of the banks money. Through foreclosure his debt is forgiven and he walks away with the $40,000. In the eyes of the IRS that money is income to be treated like any other earnings. Therefore, the bank is required to issue a 1099 so John can be taxed properly. Kind'a sucks but its the law!

Dean · Sep 25, 2010

Agreed.

John is still legally obligated for the $40K and the bank can attempt to recover it legally. If the bank chooses to not attempt recovery from John, it can deduct its loss. The $40K remains income to John.

Legally, income is income "from whatever source derived."

Congress can exempt such income if it so chooses.

Dean

Anonymous-0 · Sep 25, 2010

What is wrong with paying your bills ? It is time to get rid of bankrupty protection and bring back debtors prisons. To many freeloaders out there.

Dean · Sep 25, 2010

Agreed, again.

Dean

MarkB_MI · Sep 25, 2010

Here is the deal looking at it from the lender's side. They wrote off $40K, and will include that loss on their tax return. In other words, it was a business expense that reduces their net profit. So the IRS says: "If you had an expense, did someone else gain?". Well as a matter of fact the borrower gained the $40K they were obligated to pay. So it was technically income to the borrower, even though the money was paid when the borrower originally took out the loan. It magically transformed from a loan to income when the lender wrote off the debt.

Mike (WA) · Sep 25, 2010

Yep, the debt foregiveness is "income" in the eyes of the IRS, and taxable.
However, if its on your primary residence, its exempt. Also exempt if you are insolvent when the property goes back, also exempt if you declare bankruptcy.

I believe there's also a defense to taxability if you live in a state like Washington, where the only remedy the creditor gets in non-judicial foreclosure is the property back, and the deficiency is automatically waived by the creditor just by virtue of creditor having chosen that method of foreclosure. Because the creditor chose the method of foreclosure, I think the so-called "income" from debt foregiveness would be "income" assigned by a third party, which is not taxable.

CPAs even have trouble figuring this one out.

bison · Sep 25, 2010

why is it seen as income,How did he gain?

The borrower borrowed 200 grand,the bank foreclosed and sold the farm for 160 thou and wrote off the remaining 40.The farm was the collateral for the loan,if the bank want to loose some of the money invested by selling below value then that is their problem IMO

The original borrower has nothing left,its not like he cashed the money.

one can take it one step further and say the new buyer ended up with the 40 grand gain,so they should tax him instead.

But maybe i don"t see it straight,its not the first time

OH Boy · Sep 25, 2010

If there was actual equity in the collateral the bank would have recouped more than the amount of the loan and then I think they would be obligated to return that money to the borrower. But when the sale price wont cover the loan, there isnt any equity in the property, they are upside down.

noncompos · Sep 25, 2010

While I'm not up on these cases either, I THINK (in non recourse states) the exemption is only on the original purchase money mortgage...if a refinance has been made, it may've turned the loan into a recourse loan, subject, of course, to the forgiveness act(s)...
Secondary etc parties frozen out of the real estate by the primary's foreclosure are also instituting collection procedures on the basis of the note signed, or selling the note to professional collectors...
And if (when) filing Bkcy, be sure everyone on the note(s) files (or is somehow exempt from liability); a bank I worked for in the 60's picked up some money in cases where husb and wife signed note but only husb filed Bkcy.

Gun guru · Sep 25, 2010

Amen to that.

It seems that everybody has a big screen TV, SUV, cell phone, and all the perks of the upper middle class. (even if they cant pay for it)

I guess common sense isnt taught in college.

camju · Sep 25, 2010

Yep, if you want it all pay or do time.(HARD TIME) would be nice.

gene bender · Sep 25, 2010

Thats the way i hear it and you have to pay.

Geo-TH,In · Sep 25, 2010

I had something almost like this happen to me. Bought property on contract. Seller later wanted a cash settlement, because he was about to file ch 11. Interest rates at the bank were way more than what I was paying him. He settled for $7K less than the balance due plus an additional $3K in taxes. The IRS considered the $10k be a capital gain and I had to pay income tax on that money. My CPA was on the ball and gave me a heads up or I would have been out the $3k in taxes.

Before anyone gets to calculating, the figures above are close to the actual amounts.

George

Kevin Schmidt · Sep 25, 2010

Guess I will just have to keep working my 100 hour weeks, pay my taxes, pay my bills, and not have to worry about it........

ScottyHOMeY · Sep 25, 2010

I hadn't thought of it in terms of a foreclosure, whre the bank loses money in the subsequent sale. Still it's the same concept as a short sale or a settlement of any debt for less than owed.

The difference between the amount of debt and what is paid or otherwise recovered is seen as what's called imputed income to the person "getting off the hook." A couple of folks touched on the concept of how the taxes work. Bank loses $40K in the transaction you described. They deduct it. The guy who lost his farm gets taxed on it as income.

Anonymous-0 · Sep 25, 2010

You said ...

Also exempt if you are insolvent when the property goes back, also exempt if you declare bankruptcy. ...

and ...

CPAs even have trouble figuring this one out. ...

So - I think a CPA with some tax experience ought to know this, since you and I knew it. You do have to notify the IRS why you are claiming the exemption, and you may have to prove insolvency. You would think that letting your home go would be evidence enough of insolvency but that's too simple and logical for the real world.

M Diesel · Sep 28, 2010

(quoted from post at 12:08:39 09/25/10) why is it seen as income,How did he gain?

The borrower borrowed 200 grand,the bank foreclosed and sold the farm for 160 thou and wrote off the remaining 40.The farm was the collateral for the loan,if the bank want to loose some of the money invested by selling below value then that is their problem IMO

The original borrower has nothing left,its not like he cashed the money.

one can take it one step further and say the new buyer ended up with the 40 grand gain,so they should tax him instead.

But maybe i don"t see it straight,its not the first time

You have my vote.

If I borrow money to give to a seller, then that money isn't mine anymore. Seller has it. And had to pay taxes on the increase over the price he paid. In theory I now have a farm, but if it's value is now gone? And I'm laid off? So they take the land away, and I'm responsible for the loss? Bank still has the land, and in most states that is what they get to take back.

What the IRS doesn't have to understand is a change in value. Just because someone lost value doesn't automatically mean someone else gained anything.

Taxes are a way for govt people to have a paycheck. Hey, heard ya had some money come in. Let me have a piece and maybe we will build a road for you or something, just to make it seem okay.

And it is called a 1099-C. Expires Jan 1, 2011. Signed into law by George W Bush.

1099 for forclosures and loss anyone heared of this?

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