Law Offices of David P. Leibowitz LLC
Lakelaw is a registered assumed name for Law Offices of David P. Leibowitz LLC
As April 15 approaches, people’s thoughts turn to income tax. And when they get a form 1099 from their lender after a short sale, they start to worry. In many cases, the answer is “no worries”.
The problem is that forgiveness of debt is typically considered to be income for tax purposes. After all, you are better off if you don’t owe the money any more. You could spend the money you have on other things. So you gained. And that gain is income.
But what if you are broke and insolvent. Then you are not able to spend the money you saved. You just are less worse off then you were before. The IRS understands this and says that if you are insolvent, income from forgiveness of debt isn’t taxable even if you get a 1099 from your lender.
In addition, the Internal Revenue Code was amended in 2007 through the year 2012 to provide that income in respect to forgiveness of debt on a short sale of your principal residence is not taxable. So if you sold your house on a short sale last year, you are also good to go.
There are other ways to limit the pain of forgiveness of debt. If you file a bankruptcy case, you will usually be deemed to be insolvent and not have any income in respect to forgiveness of debt. And if you have any remaining property you can “reallocate tax attributes” to other property you may own. If you don’t know what this means, ask your tax advisor since this is somewhat technical.
We at Lakelaw are not tax attorneys. But we do know about bankruptcy, insolvency and mortgage foreclosure. And when we need to, we know about other areas of law which relate to our areas of concentration. And as always, we stand ready to serve you with care, kindness, courtesy, respect, professionalism and dedication.
This year’s April 18th deadline for filing taxes is almost here, and that means many of us have already filed our state and federal taxes and – hopefully – received a refund. Sometimes we will meet someone who had the good luck to get back $4,000, $6,000 or even $8,000 back from the IRS. But that money isn’t always enough to balance their finances, and they still need to file for bankruptcy. What to do about that spent refund when the trustee asks about it?
Our first piece of advice is always to keep track of where the money went. Usually there is a very simple answer for why that $6,000 refund is down to $500. $3,000 went to property taxes. $500 went to badly needed car repair. $1,000 was spent on fixing the leaky roof. And $1,000 went to catching up with the gas and electric bills. That sounds more reasonable than “It’s all gone”, because every dollar is accounted for. The second thing to remember is to hold off on paying back close friends and family members for loans. It sounds unfair to wait when the money is finally in front of you, but repaying family in large amounts (especially $500 or more) is considering making a “preference” to one creditor over all others. That money can be recovered from a trustee, so that $2,000 repayment goes back to your creditors instead of your parents.
Finally, waiting can be the best answer. Sometimes, waiting a few months is a good way of showing that your tax refund wasn’t enough to take care of all the medical bills, credit card debts and other bills. If you are expecting a large refund, or have already received one, call the attorneys at Lakelaw to discuss your financial options.
Posted by David Leibowitz on February 10th, 2011 in Bankruptcy and Taxes
Banks frequently will send you – and the Internal Revenue Service – a form 1099C after you have completed a short sale of real estate. What does this mean? Well, if you owed the bank $250,000 and sold the house for $200,000 payable to the bank, there could be income tax consequences? Why?
Forgiveness of indebtedness is generally considered to be income. In other words, if you paid $200,000 to settle a $250,000 loan, you are considered to have received income in the amount of $50,000. As a matter of fact, this is “ordinary income” which can be taxed at rates approaching 40% when taking into account state income taxes.
But if you had to have a short sale, it’s probably because you were in financial difficulty in the first place. So if you file a bankruptcy after a short sale leading to “forgiveness of indebtedness income” or if you are insolvent – meaning less assets than liabilities – you may not be required to pay income taxes even if the bank stuck you with a IRS form 1099C. The IRS has issued a very good explanation of the entire situation here. The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
So if you succeed at a short sale, you have a very good chance of avoiding income taxes in respect to cancellation of debt. When in doubt, contact us at Lakelaw, Your Financial Lifesaver ™.