Mortgage Debt Forgiveness: What Happens at Tax Time?
My house was sold by the sheriff and there is a balance left. What could possibly go wrong?
There are two scenarios that may play out in Ohio when it comes to mortgage deficiencies following foreclosure:
- The first is that the lender may walk away from the deficiency, and
- The second is that the lender secures a deficiency judgment which it may attempt to enforce through bank attachments and wage garnishments.
We know that bankruptcy is the oft-preferred method of dealing with the second (deficiency judgment). But is it all sunshine and light when the lender forgives the remainder of the debt?
If the tax laws don’t permit exclusion of the forgiven debt, a monstrous tax bill at the end of the year may result. However, bankruptcy may provide both debt relief and potential tax debt relief if filed in a timely fashion.
What Happens When a Creditor Forgives Mortgage Debt?
Few events cause more tumult in a person’s life than a home foreclosure and an unforeseen tax debt. Debt forgiveness can be both a relief and then a substantial burden due to the imputed income that you must report to the IRS.
When a creditor forgives mortgage debt, the beneficiary of that forgiveness receives a 1099-C form. This indicates that the taxpayer no longer owes either a partial or total balance on outstanding debt. This form must be filed with the IRS and amounts therein may be counted as income.
Ironically, the lessening of one’s debt burden can lead to an increased tax liability and exacerbate one’s financial troubles. However, there are ways to avoid this “income” and lessen the financial burden. In many cases, these forms of tax debt relief come from certain federal laws that may allow the “gains” realized from the forgiveness of the debt to be excluded from the taxpayer’s annual income.
Was the Taxpayer Insolvent?
The first step is to determine if the taxpayer was insolvent before the debt was forgiven. This simply means that one’s liabilities were greater one’s assets.
Assets include everything from houses and cars to stocks, bonds and retirement accounts. Liabilities are the current debts owed to any lender. If the value of the liabilities exceeds that value of the assets, then a taxpayer qualifies for the insolvency exclusion and need go no further.
Bankruptcy Gives You a Completely Clean Slate
If one is not insolvent according to tax law but otherwise qualifies for a discharge, or if a person just wants to wipe the slate clean of any potential existing obligation, the taxpayer can file bankruptcy. All debt discharged in bankruptcy is not subject to taxation by any taxing authority. This is true regardless of whether or not a 1099-C has been received. Many prefer this option since it results in a completely clean slate and fresh start.
Learn More About Tax Debt Relief and Bankruptcy
For more information about mortgage debt forgiveness, deficiency judgments, and tax liability, speak to a Cleveland OH tax debt relief attorney at Benson Law Firm today.