1099-MISC and Secured Debt

Community Leader
Registered: 03-17-2003
1099-MISC and Secured Debt
Mon, 02-27-2006 - 8:36pm

Home Foreclosures - Tax Effect

Question: Can I be taxed on my foreclosed home?
Answer: Yes.

Why and How You Get A 1099-MISC: Thanks to the 16th Amendment, IRS gets to tax your income. Since IRS expects that you will repay money you borrow, it does not tax income which is only a loan. If a creditor forgives the loan and says, for whatever reason, you do not have to repay it, IRS changes its mind and taxes the loan as if it were ordinary income. If IRS didn't do this an employer could make your wages tax-free by loaning your pay to you and later forgiving the loan. (Those IRS guys are shrewd aren't they?)

When a lender forecloses on a mortgage, it usually sells the home to the highest bidder at auction. The lender may not get the full balance of the loan. (Think twice before you take advantage of the HELOC, 2nd mortgages, 3rd mortgages and mortgages with high loan-to-value ratio e.g. 125%.) The portion of the loan that is not repaid by the foreclosure sale is the unsecured part of the loan or the deficiency. Some states (Arizona, for example) limit the ability of a lender to come after the borrower for a deficiency on home loans. If the lender forgives the deficiency because of state law or for other reasons, IRS will re-classify this part of the loan as income to you, and require that you pay income tax on it.

This also happens with car loans and other secured debt.

If you settle debt, go through a foreclosure or repossession, do not think that is the end of your dealings. You will get a 1099-MISC about the time the IRS receives their copy of your "income."

This can be avoided with Bankruptcy.