Feb 16

Phantom Income Resulting From Foreclosure


When a lender forecloses on someone’s primary residence not only do they suffer the humility of losing their home, but in the aftermath a goodly portion of salt is rubbed in their wounds when they receive 1099 reporting the difference between what they owed on the home and the amount of money the bank realized when the home was sold as income, even though they never received a dime in the sale to pay the taxes on this phantom income. This phantom income, income that is attributed to a debtor/tax payer as a result of losing their home and not paying back the full loan, comes as a real shock and a real burden. After all, honestly, who has the funds to pay taxes on money you never saw, when the whole reason for the foreclosure, was that the borrower did not have enough income to pay the loan in the first place. This problem has been exacerbated due to the housing price bubble that developed in the 90s and early 2000s as a result of lax lending practices which came about due to lax governmental regulatory practices. Fortunately for those poor souls who end up losing their homes to their lenders after buying at artificially inflated values, there has been some help. In 2007 congress passed The Mortgage Forgiveness Debt Relief Act which is good until December 31 2012. The California version is good toward state taxes until 2013. The end result of the act is that if a debtor’s primary residence is lost to short sale or foreclosure and debt is forgiven as a result, even though the lender still sends the borrower a 1099, the unpaid amount of debt is not counted as income and is not taxed. This works for up to $2,000,000 in forgiven (unpaid) debt. The borrower will still receive a 1099 from the lender reporting the unpaid portion of the obligation as income, but at the time of filing their tax return the borrowers will fill out IRS form 982 which prevents the proper amount of forgiveness from becoming income.

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