Have You Received a 1099 Form For Canceled Debt From Your Lender and Don’t Know What to Do With It?

The cancellation of debt, or COD, occurs when a lender cancels or forgives a debt that you owe. This is commonly seen in the occurrence of a foreclosure of a mortgage or in the short sale of a home. If a home sells at a foreclosure sale for less than the amount owed against it, your lender may forgive the remaining debt. The Internal Revenue Service considers that forgiven debt a source of income to you. The same is true if you short sell your home; meaning you get your lender to agree to allow you to sell the property for less than the amount that is owed. This type of income is frequently referred to as 1099 income. That is because your lender is required to fill out a 1099-C or 1099-A form and file it with the IRS if it cancels any debt owed by you.

Financial institutions, in certain circumstances, are also required to treat debt as cancelled after 36 months of non-payment. Non-payment for this length of time creates a presumption in the eyes of the IRS that the loan was discharged and triggered the lender’s obligation to file a 1099-C. If a lender can show, however, that it has been making a real attempt to collect the debt even after the 36 months, then the IRS may not consider the debt cancelled.

This 36-month testing period often causes significant confusion for debtors who receive 1099 forms and do not know whether to report the COD as income. In response to this confusion, the IRS has recently proposed regulations that would eliminate a lender’s reporting requirement of the 36-month testing period. The proposed regulation can be seen here.

A taxpayer should be charged with COD income only if a debt has been truly discharged by a lender. The Internal Revenue Service’s proposed elimination of the 36-month testing period, if and when finalized, will hopefully reduce taxpayer confusion as to when to report cancelled debt as part of their gross income.

When reported properly, most instances of forgiven debt, particularly those associated with real estate property, do not give rise to a tax liability. But the key is to make sure the information is properly handled on your tax return.

If you have received a 1099-C form from a creditor and are unsure of how to report the income on your 2014 income tax filings, the professionals at Nielsen Law Group can assist you in reviewing your financial documents today. Call (480) 888-71111 or submit a web request here.