What is debt cancellation and why is it such a common theme in today’s real estate and tax world?
In the current economic climate, thousands of homeowners are receiving reports from lenders showing large income amounts as a result of the Cancellation of Debt. January 31 was the date by which lenders were obligated to send out Form 1099-A or Form 1099-C (see Canceled Debt and Form 1099-C). These forms are sent to both the IRS and the borrower. You can expect to receive one of these forms if you have had either a foreclosure or other transaction (i.e., short sale, deed-in-lieu of foreclosure, etc.) which may have led to an amount of debt being canceled.
Debt cancellation is found in Section 61(a)(12) of the Internal Revenue Code. Commonly referred to as COD (“Cancellation of Debt”) income. Originally this type of income was recognized by the courts and then later codified in Section 61(a)(12).
The premise behind this form of income is that when a a loan is given, there is no “accession to wealth” since there is an obligation to repay it. Meaning that, although a taxpayer has an increase in assets by receiving property or money, there is an offsetting liability that is represented by the borrower’s obligation to pay the lender back. However, when a loan, or portion of a loan, is later forgiven, this gives rise to an “accession to wealth”. It is this rise in assets or tax benefit that a taxpayer receives which is the motivation for the government’s tax position.
Amounts listed on Form 1099-C may be contested (see Question #6 at www.IRS.gov here).
The following is an excerpt taken directly from the IRS website:
“6. I don’t agree with the information on the Form 1099-C. What should I do?
Contact the lender. The lender should issue a corrected form if the information is determined to be incorrect. Retain all records related to the purchase of your home and all related debt. (see http://www.irs.gov/newsroom/article/0,,id=174034,00.html).”
There are several provisions in the tax code that provide ways to either minimize or eliminate this type of income tax. Be careful to get competent tax advice prior to engaging in a transaction. Once a foreclosure has been completed it may be too late to avoid a tax liability. Please contact your tax advisor or our offices as soon as your are aware that you may be faced with some form of debt cancellation.
Contact me at jsr@qsrlaw.com or call my office at (619) 231 – 6655 x 104.
John S. Reynard III, Esq., LL.M.
Quintana | Reynard
A Professional Law Corporation
Main Line: 619.231.6655 x104
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e-mail: jsr@qrlawfirm.com
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The foregoing information is presented by Quintana | Reynard, APC as a news reporting service to clients and friends of the firm and is distributed with the understanding that Quintana | Reynard, APC is not rendering legal advice and assumes no liability whatsoever in connection with its use. If you have questions about the subject matter presented or desire to obtain more information on legal issues related to your business, please contact us at (619) 231-6655 or email us at jsr@qrlawfirm.com.
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