Wilmington NC CPA discusses Short Sales, Insolvency, IRS Form 982, and Form 1099-C

Short Sales are still common secondary to the recession. Short Sale just means you sell your home for less than the amount of your outstanding mortgage(s). Some folks call this situation “upside down”. Often, the homeowner gets the bank to write off or cancel the remaining debt. Your lender then sends you, and the IRS, a Form 1099-C (Cancellation of Debt) reporting this amount in Box 2. The IRS automatically considers the amount shown on Form 1099-C taxable income. This may seem strange since you didn’t actually receive money. But you may be able to exclude some or all of the cancelled debt by filing Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness and Section 1082 Basis Adjustment) and attaching it to your Form 1040 return.

Publication 4681: Canceled Debts, Foreclosures, Repossessions, and Abandonments (For Individuals)

Publication 4681 can be found on the IRS website. While we advocate folks self preparing tax returns, Short Sales is an issue where that may not be prudent or even possible. Although Form 982 is well delineated in Publication 4681, it seems to me most folks have trouble following it without some tax training or accounting experience. Not a problem with the IRS, just a complex issue. And the tax consequences may be thousands of dollars.

Foreclosures vs. Short Sales

Foreclosure is different than a Short Sale. Generally, but with a few IRS wrinkles, you can exclude the amount of foreclosure from taxable income if you complete Form 982 and attach it to your return. Short Sales are more complex and rely on the insolvency exclusion on Form 982.

Form 1099-C Considerations

The amount in Box 2 should be verified. You are entitled to a reconciliation of that amount by the lender. For Short Sales, the date your debt was forgiven is also important. Lenders sometimes default to December 31st. For Short Sales, you can exclude the amount of cancelled debt, via Form 982, to the extent you were insolvent immediately before the debt was forgiven. So the date can be critical. Finally some creditors seem vengeful and only send the IRS a copy of the 1099-C. Or maybe your copy gets lost in the mail. If you think you should have gotten a 1099-C, but didn’t receive one, check it out.

Insolvency on Form 982

The IRS allows some exceptions and exclusions on Cancelled Debt where it isn’t taxable income if you qualify and complete Form 982 correctly. Insolvency is one such exclusion and may be appropriate for reporting Short Sales. As with all IRS issues, insolvency is not as clear cut as one might hope. In this case, insolvency does not mean bankruptcy.

If you throw up your hands after reading Publication 4681 and decide you need some help preparing Form 982 using the Insolvency exclusion for your Short Sale, please consider calling us for a gratis initial phone consult at (910) 399-2705. While we’re a Wilmington NC CPA firm, we serve a wider geographical base. Please read some of our other posts on cancelled debt and Form 982 to help ascertain our expertise and proactive philosophy.