As tax time approaches, I have been receiving a blizzard of emails about IRS Form 1099-A from readers trying to figure out what to do on their tax returns. Here are some Frequently Asked Questions (FAQ’s) that may help. But first, I can’t emphasize this enough: I am not a tax expert!!!! This is not tax advice. It’s just information that I have picked up from my wanderings in this field of law. In order to determine whether you have a real COD tax problem, you must seek competent advice from a good tax accountant. Why? Because if you get it wrong, you need to have cover.
I received a Form 1099-A. What is and what should I do?: If you have received a Form 1099-A in the mail, chances are it’s because you lost a piece of real estate to a foreclosure in 2010. As you have probably learned by now, the cancellation of debt MAY be a taxable event. The Form 1099-A DOES NOT mean you have cancellation of debt (“COD”) tax. All it means is that the lender that foreclosed on the property has taken property back in partial satisfaction of the debt that was owed. It also DOES NOT mean that the debt has been canceled. Again, all it means is that the part of the debt has been satisfied with the foreclosure of real property.
If I received a Form 1099-A, does that mean that I will receive a Form 1099-C at some time in the future? Probably not. The Form 1099-C is an acknowledgement by the lender that the debt has actually been cancelled. Banks are not likely to tell you that, because they want to preserve their ability to come after you later.
If I received a Form 1099-A, should I report the cancellation of debt on my 2010 tax return? Maybe. This is probably the trickiest issue. The tax accountants I have talked to about this issue (Spoiler Alert: There aren’t many who understand it) have told me that they advise the taxpayer to prepare and submit a Form 982 with a possible “estimate” if there is a potential COD problem lurking in the weeds. In fact, it appears that if there has been any COD at all, then Form 982 is apparently required to be filed with the tax return, but I have no opinion on that and honestly don’t have a clue as to possible consequences for failure to file the Form 982 if there is no COD tax owed.
What if I got a 1099-C? The issuance of a Form 1099-C means that the debt has been cancelled. If you live in California, this may be triggered by the fact that your loan was a “non-recourse loan,” i.e., protected from the risk of deficiency by one or more of the Big 3 California anti-deficiency statutes, CCP §580b, CCP§580d or CCP§580e. It may have been becaue you filed bankruptcy, and your debt was discharged in that proceeding. (COD which occurs in bankruptcy is not taxable.)
So what do you do? Well, IRS Regulations (specifically, 26 C.F.R. 1.6050p-1) require you to report the cancellation of debt, whether or not it is ultimately taxable. You do this by means of the IRS Form 982.
And will you owe tax? Well, here are the categories in which you will categorically NOT owe COD tax:
1. If the debt was discharged in bankruptcy.
2. If the cancelled debt was incurred to purchase, construct or substantially improve your principal residence. This is the result of the Mortgage Debt Relief Act of 2007.
3. If you were “balance sheet insolvent” at the time of the cancelation of the debt. Balance sheet insolvent is very simple: If the value of your obligations is greater then the value of your assets (including IRAs) you are “balance sheet insolvent.” The trick here is to create a paper trail so that when the IRS comes a-knocking on an audit a couple of years from now, you will be able to demonstrate that insolvency.
The real issue seems to be: Has the debt been cancelled? Form 1099-A doesn’t answer that particular question, and unless the debt was specifically non-recourse, the lender is not likely to send you a 1099-C.