Cancelled Debt and Insolvency

[peggysioux]

Taxpayer had a short sale on rental on 4/27/12 and received one 1099-C on 4/30/13 and a second 1099-C on 5/30/12. In completing the insolvency worksheet, taxpayer would not include the rental loan as debt being he no longer owns, correct? Taxpayer is reading the insolvency worksheet and the wording is "debts immediately prior to cancellation of debt and his thinking is 4/27 is immediately prior to the cancellation of the first 1099-C so he thinks he should be able to include. I say not includible but wanted other tax preparers feedback.

[mactoolsix]

Taxpayer had a short sale on rental on 4/27/12 and received one 1099-C on 4/30/13 and a second 1099-C on 5/30/12. In completing the insolvency worksheet, taxpayer would not include the rental loan as debt being he no longer owns, correct? Taxpayer is reading the insolvency worksheet and the wording is "debts immediately prior to cancellation of debt and his thinking is 4/27 is immediately prior to the cancellation of the first 1099-C so he thinks he should be able to include. I say not includible but wanted other tax preparers feedback.

Are your years correct?
Sold 4/27/12
First 1099-C on 4/30/13
Second 1099-C on 5/30/12


Mike

[Gary2]

Taxpayer had a short sale on rental on 4/27/12 and received one 1099-C on 4/30/13 and a second 1099-C on 5/30/12. In completing the insolvency worksheet, taxpayer would not include the rental loan as debt being he no longer owns, correct? Taxpayer is reading the insolvency worksheet and the wording is "debts immediately prior to cancellation of debt and his thinking is 4/27 is immediately prior to the cancellation of the first 1099-C so he thinks he should be able to include. I say not includible but wanted other tax preparers feedback.

I assume you mean the first 1099-C had an box 1 (event date) of 4/30/12, and the second had a box 1 of 5/30/12. Obviously, the date the taxpayer received them is irrelevant. It's less clear whether both loans relate to the same real estate, but it isn't likely to matter.

On a short sale where the debt will be canceled, I'd expect the events to coincide - i.e., the debt is canceled at the same instant the sale occurs. I wouldn't be surprised if the lenders messed up the dates to match when they updated their books, but that's probably wrong. Check the paperwork to see if that's what was called for.

In any event, regardless of whether the dates for the 1099-C are correct, you would include their respective values as liabilities, including any amount that would be paid off by the short sale, since they exist prior to the cancellation. If you treat the events as coincident, you'd also include the value of the property as an asset. Thus, in a typical short sale where the loan balance is, for example, $120,000 but the house sells for $100,000, you'd have an asset of $100,000 and a liability of $120,000 on the worksheet - even though the amount canceled would only be $20,000 (ignoring other expenses and details).

[peggysioux]

Insolvency and 1099-C

Sorry, I mis-typed. The first 1099-C is 4/30/12 and the sale of the property was 4/27/12. How does it work if the 1099-C is not issued until, say, 6 months later, than the debt and asset of the short sale would not be included? If the taxpayer no longer owns the property, how would the asset and debt be included in insolvency worksheet?

[Gary2]

Sorry, I mis-typed. The first 1099-C is 4/30/12 and the sale of the property was 4/27/12. How does it work if the 1099-C is not issued until, say, 6 months later, than the debt and asset of the short sale would not be included? If the taxpayer no longer owns the property, how would the asset and debt be included in insolvency worksheet?

First, lenders are notorious for being late with the 1099-C. So it's up to you to understand the rules for issuing the 1099-C. I suggest reading the 1099-A/1099-C combined instructions from the IRS web site. It's also up to you to understand what the exact agreement was between the lender(s) and borrower with regard to the short sale and the canceled debt. Keep in mind that short sales are commonly, but not necessarily connected to cancellation of the debt. If the short sale agreement said that the lender would definitely cancel the remaining debt when the sale closes, then the correct date for the 1099-C is the date of the closing, not six months later.

Second, you seem to be tying the loan to the ownership of the property. That's wrong; the property ownership and the loan are two separate items, connected solely by a lien. There's no reason (other than risk) that a lender couldn't agree to a short sale, release the lien, but continue to hold the remainder of the loan as an unsecured loan, which might be paid off eventually or could be canceled at a later date.

Finally, regardless of any of the background information, since the insolvency worksheet is always based on the situation prior to the debt being canceled, then the full amount of the canceled debt is always included on the insolvency worksheet. Whether or not any assets associated with the debt are also included depends on the particular situation. In the common short sale case, the FMV of the asset is included on the worksheet, and the full amount of the loan (which is more than just the amount canceled) would also be included.