I have had quite a few conversations lately about the capital gains tax that results from a short sale or foreclosure, and what exactly what you should do when the lender sends you an IRS Form 1099-C.
First of all, as a quick disclosure to first-time readers …
OK, my “I’m not a Tallahassee accountant” disclosure is out of the way, let’s get back to the topic at hand regarding IRS Form 1099-C.
What Is An IRS Form 1099-C
Recently, a long-time reader asked “why did I get a IRS Form 1099-C from the lender, and what does the amount on the form represent?”
I gave him my “I’m not a Tallahassee accountant disclosure” and explained that the Form 1099-C is sent by the lender as a “forgiveness of debt.” The following comes from the language right on the form:
Instructions for Debtor – IRS Form 1099-C
You received this form because a Federal Government agency or an applicable financial entity (a lender) has discharged (canceled or forgiven) a debt you owed, or because an identifiable event has occurred that either is or is deemed to be a discharge of a debt of $600 or more. If a creditor has discharged a debt you owed, you are required to include the discharged amount in your income, even if it is less than $600, on the “Other income” line of your Form 1040. However, you may not have to include all of the canceled debt in your income. There are exceptions and exclusions, such as bankruptcy and insolvency.
Basically, the way I understand it is the IRS Form 1099-C has one of two purposes for a real estate investor who disposes of a distressed property:
- Through Foreclosure: The amount on the 1099-C represents the same thing as a sales price would had you sold the property. From that price, you should be able to deduct your cost of sales (in the case of a foreclosure, legals costs paid, etc.), your basis, and you most likely have some recapture to add back in. For simplicity sake, think of the amount as the gross sales price attained.
- Through Short Sale or some other non-foreclosure sale remedy: The amount on the 1099-C should represent the total loss realized by the lender (loan amount + interest + penalties + legal costs minus net from sales). I have heard of all sorts of numbers that come back from this, but it really should be an amount equal to what they took as a loss. This number then should be added into your formula when calculating your tax on home sales gain [loss] (capital gains tax rate multiplied by [net from sales - basis + debt forgiveness + recapture]).
Scrutinize Your IRS Form 1099-C
Here’s two additional questions to ask your Accountant:
- Has the lender properly calculated the IRS Form 1099-C amount?
- Can the lender add to the IRS Form 1099-C any uncollected fees to their loss, or must it be purely principle, interest, and penalties only?
I hope this helps clear-up what to do (tax wise) after you dispose of an investment property through short sale, deed-in-lieu, or foreclosure. If you have any additional questions or comments about the IRS Form 1099-C, post them below in the comments section and I will reach out to some Tallahassee accountants to chime in for the right answers.
About Joe Manausa, MBA
