I am planning a strategic default on my under-water home. Will the IRS may tax me with a 1099? Will a form 982 protect me?

Asked over 2 years ago - Fresno, CA

My house is $70,000 under water and I am planning a strategic default. I look at it as a bad investment. The house is my sole residence, and has never been refinanced. My concern is the IRS. I worry about the IRS taxing me on the difference between what I owe on the house, and whatever the bank gets for it. I'm told the difference may be considered taxable income. Would I likely receive a form 1099 from the IRS? Can I file a form 982 to make the "income" from the 1099 non-taxable?

Attorney answers (5)

  1. Steven Alan Fink

    Contributor Level 20

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    Answered . Tax laws have been changed to protect foreclosed homeowners from paying taxes on the so-called "profit" in not having to pay off the loan. You are safe to default this coming year under theMortgage Forgiveness Debt Relief Act of 2007.

    The response given is not intended to create, nor does it create an ongoing duty to respond to questions. The... more
  2. Frank Wei-Hong Chen

    Contributor Level 20

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    Answered . Under the federal Mortgage Debt Forgiveness Tax Relief Act of 2007 (applicable till the end of 2012), you might not need to pay any income tax on canceled debt (which is the unpaid loan balance that is forgiven by lender) resulting from a foreclosure, short sale or deed in lieu of foreclosure if you as the borrower satisfy certain conditions for mortgage tax relief (e.g., principal residence, owned for at least 2 years, debt amount of $2 million or less).

    IRS Code section 121 defines "principal residence" as: ". . . during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer's principal residence for periods aggregating 2 years or more. " In short, if you lived in a home you own for 2 of the past 5 years from the date of sale, it is considered a principal residence. Simply go back 5 years from the date of the sale and if you lived in the home for a total of 2 years, it qualifies as a primary residence.

    For more information on debt foregiveness and 1099-C, see:

    The information presented here is general in nature and is not intended, nor should be construed, as legal advice.... more
  3. Christopher Michael Larson

    Contributor Level 19

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    Answered . You possibly can. This will not be recognized income under Section 108(a)(1)(E) if:

    the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2013.

    So recognition of income will likely not be an issue. Use the Form 982, and just make sure you check the proper box in 1(e).

    Christopher Larson
    Insight Law
    www.insightlawfirm.com

  4. Steven Anderson Leahy

    Pro

    Contributor Level 17

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    Answered . There are a number of exclusions to remove cancelled debt as income. The provisions mentioned in the prior posts - but also, insolvency. If you were technically insolvent at the time the debt was cancelled - that is your liabilities are greater than the fair market value of all your assets- an exclusion is available and may apply.

  5. James H Sutton Jr.

    Contributor Level 13

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    Answered . This is not really a tax response, but it is very much worth noting. I've seen quite a few people go through a strategic default and no one gave them the advice that they should get a deficiency waiver from the bank. The deficiency waiver says that the bank relinquishes its right to come after you for any of the unpaid debt. Receiving a 1099 for the forgiving debt does NOT release you from the debt.

    You need to negotiate this with the bank and the bank may require you to pony up a little more money to get the waiver. This will be money well spent.

    What we are seeing in Florida is the banks are selling the defaulted mortgages in bulk to collection agencies for pennies on the dollar. The collection agency then uses aggressive tactics to collect on the unpaid part of the mortgage. They can lien other assets, garnish wages, etc, etc. It can be real nasty for someone like yourself that could have paid the debt but did not.

    I hope this adds a little useful information to the prior good answers.

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