IRS Form 982 CPA explains Short Sales and Foreclosure Cancelled Debt | Reduction of Tax Attributes | IRS Form 1099-C Cancellation of Debt | Form 1099-C instructions | Form 982 instructions

IRS Form 982 CPAs still expect to see a lot of Cancelled Debt from Form 1099-C, Cancellation of Debt, in 2015. Why? Unfortunately, there were still lots of 2014 short sales and foreclosures. My call volume is actually higher thus far in 2015 compared to 2014. I’m discussing primary residence cancelled debt here. That exclusion on Form 982 got extended in mid December. Form 982 CPAs are delighted, to say the least.

• We handle S Corporation rental property cancelled debt. Don’t expect the Form 1120-S instructions to be all that helpful. The 2013 1120-S instructions don’t even reference the line on Form 1120-S where you enter cancelled debt.
• We handle Partnership cancelled debt. Don’t expect the Form 1065 instructions to be any better than the Form 1120-S instructions.
• The Form 1099-C instructions are no help; they’re for the bankers.
• I’d suggest reading Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, as a prelude to reading the Form 982 instructions. Why? It helps you to get familiar with IRS terminology.

I’m only dealing with personal cancelled debt here, but some concepts for S Corporation cancelled debt and Partnership cancelled debt are valid. It’s amazing how protracted the cancellation of debt process can be. I had a call today from a woman with a 2014 Form 1099-C for a car repo 10, yes, 10 years ago.

“Cancelled debt becomes taxable income on Form 1040, unless you can exclude it via Form 982, Reduction of tax Attributes. Form 982 presents multiple approaches for excluding cancelled debt from taxable income. Don’t pay any tax on a Form 1099-C until you’re certain you’ve looked in every nook and cranny of Form 982.”
- Gary Bode, Form 982 CPA and cancelled debt tax accountant

Note that with a primary residence 1099-C there are usually no present or future tax consequences. Why? You can’t deduct a loss on your primary residence and there’s a $500,000 capital gins exclusion for your primary residence. So you basically jump through IRS hoops to end up with no additional tax due.

Why are the Form 982 instruction so convoluted?

Here’s part of the reason folks complain about the IRS language in the Form 982 instructions and Publication 4681; the IRS has to cover a broad range of cancelled debt circumstances. Making pertinent information hard to find. The IRS jargon and writing style means most Form 982 CPAs rely on a third party subscription database that covers all cancelled debt tax treatment in one place with relevant examples. I personally read the Form 982 instructions every year and even for me, with years of experience, they’re a hard read.

This post discusses the Mortgage Forgiveness Debt Relief Act provision of Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), which is available to taxpayers through 2014. Your bank’s debt forgiveness on the home’s short sale, foreclosure or HELOC (subject to circumstances) is almost automatically excluded from taxable income. Just fill out IRS tax Form 982 using information from Form 1099-C.

Form 982 Part I, General Information

The term Short Sale commonly refers to selling property for less than what you owe in mortgage(s). Foreclosure refers to the lender re-possessing your property.

Form 982, Part II

A third scenario exists; your loan is re-structured IE you keep your home but the lender forgives some amount of debt. Again, this Form 982 calculation is complex and subject to multiple IRS parameters. We handle HAMP and HELOC loan modifications.

“Your second mortgage or primary residence line of credit had to be used to buy or improve your primary residence. If not you’re stuck using the insolvency exclusion on Form 982. Sometimes only past of the second mortgage qualifies for the Mortgage Forgiveness Debt Relief Act provision of Form 982.”
- Gary Bode Form 1099-C CPA and cancelled debt tax accountant

The Difference between Form 1099-A Form 1099-S and 1099-C, Cancellation of Debt?

Form 1099-A reports a “sale” of your property through foreclosure or abandonment. Sometimes a Form 1099-A gets issued because the home “sold” or changed hands before the actual cancellation of debt occurs. If you receive IRS tax Form 1099-A, be on the alert for a subsequent Form 1099-C. Sometimes Clients don’t receive Form 1099-C because they moved. So they didn’t report the cancelled debt on their tax return. Their first hint of cancelled debt occurs when an IRS Notice CP2000 arrives “proposing” taxes on the entire amount of the Form 1099-C.

Form 1099-C shows cancelled debt.

Form 1099-S reports the sale of real estate to both the seller and the IRS.

With Form 1099-A or Form 1099-S I recommend listing the sale of your home on the 2013 Form 1040. That’s easy to do. Capital gain is unlikely in a foreclosure, and you can exclude up to $500,000 (for a married couple) of capital gains on the sale of your primary residence anyway. I’ve seen the IRS come back and try to tax folks on the full fair market value of the foreclosed home. Ouch.

“Some folks get so focused on the cancelled debt that they forget there’s a real estate sale transaction too. A few cancelled debt clients ignored Form 1099-S and/or Form 1099-A and then came to us after the IRS demanded back taxes on the entire sale price. ”
- Gary Bode, IRS Form 982 CPA

Other Uses of IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)

• Bankruptcy (Title 11).
• Insolvency. Please see our post on Form 982 Insolvency.
• Farm Debt.
• Real Property Indebtedness.

It pays to read IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

Ignorance is not Bliss

Some lenders, especially in credit card debt cancellation, pull a nasty trick and only send 1099-C to the IRS. Your copy gets lost in the mail. So, you prepare Form 1040 without the 1099-C. The IRS eventually sends you a CP2000 Notice asking for back taxes on the cancelled debt. Here, you would probably file an amended return, Form 1040-X and still use Form 982 to exclude the cancelled debt. But it is easier and more cost-effective to file Form 982 with the original return.

Can you prepare IRS Form 982 yourself?

Sure. Excluding the cancelled debt from IRS tax Form 1099-C, Cancellation of Debt, is straight forward for your main residence. Reduction of tax attributes is the tricky part. The IRS provides some nice examples. Here are some factors to consider:

• There’s more info about Form 982 available now. For example, we have dozens of posts on cancelled debt, Form 1099-C, Form 1099-A, Form 982, short sales and foreclosures. Please find them by using the drop down lists in the right sidebar. Maybe your circumstances are easy enough to self prepare Form 982.
• The IRS website provides good information. Plus there’s their Publication 4681.
• If you get uncomfortable with Form 982, consider calling us for a free consult.
• The breakeven point to use a Form 982 CPA can be $800 of cancelled debt.
• On most Form 982 cases we exclude thousands of dollars of taxable income.

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10 facts that the IRS wants you to know about Mortgage Debt Forgiveness (cut and pasted for your convenience).

This information changes with time so make sure you get the latest info.

1. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act (available through 2012) , you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.