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:
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.