Exceptions to 1099

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There are three exceptions to issuance of the 1099:

  1. If the property lost in foreclosure is a principal residence (where you live) then the cancellation of the debt (“COD”) generally won’t be taxable. This is a result of the Mortgage Forgiveness Debt Relief Act of 2007, which expires on December 31, 2012.
  2. If you are “insolvent” at the time that the debt is cancelled (not at the time of the foreclosure) then you will not be taxed. Insolvency is a simple balance sheet test: If your liabilities exceed your assets, you are insolvent.  Many taxpayers may meet the insolvency test for these purposes although they might not think of themselves as destitute.  The potential losses on all your upside down properties as well as that decrease in value in your home over the past few years are all taken into consideration. You will have to submit IRS Form 982 with the tax return in the applicable year in order to demonstrate that insolvency.
  3. If the debt is cancelled as a result of a bankruptcy filing, then there is also no tax. (This is one of the reasons bankruptcy is often referred to as “the ultimate mortgage modification tool.”)