Taxes Resulting From Foreclosure and How to Avoid Them
If your home is foreclosed, sold at a short sale, or if you give the home back to your lender in satisfaction of your debt, IRS Tax Fact 10 tells us to watch for a 1099-C or 1099-A statement in the mail during the next calendar year. Lenders are required to send the 1099 forms by the last day of February in the year following the tax year in which debt cancellation or forgiveness occurs. When you get the 1099-C, look at it carefully. If you think something is wrong on the notification, call the lender who issued the statement and see if you can get them to correct it. This is easier said than done but the IRS recommends that you take this course of action.
When looking at a Form 1099 that involves debt cancellation, you should pay particular attention to the amount of debt listed as forgiven in box number two as well as the value listed for your home in box number seven. The amount of debt forgiven should be the value of your home at the time the debt was cancelled subtracted from the amount of debt you owed. If either of those numbers are wrong, you could end up paying more tax than you owe.
Remember, if you received a 1099-C as a result of a foreclosure, short sale or deed in lieu of foreclosure, the amount reported as cancelled debt will be considered as income unless you file a Form 982 with your federal tax return. A copy of your 1099 is sent to the IRS and a computer will match it against your return after it is filed. If there is a mismatch, you may be sent a Form CP2000 letter suggesting that you owe more tax.
If the numbers on a 1099 are incorrect, there are some procedures by which you can contest the error. If the 1099 was sent by someone with intent to harm you, federal law allows you to collect statutory damages and attorneys fees if you must go to court. Tax professionals know how to deal with erroneous 1099 reports. If you are unable to convince your lender to correct the 1099, it is time to see a tax lawyer for help.