Bankruptcy and 1099 taxable income 

Bankruptcy and 1099 taxable income

When you file bankruptcy or settle a debt a creditor will almost always file a 1099 which claims you made money by bankrupting or settling a debt.  If you settle the debt you owe the tax due to an increase in taxable income.  But in bankruptcy there is no taxable income.  Section 6071(c) requires the bank or employer to file Form 1099.

So what do you do if a creditor files a Form 1099 after you discharged the debt in bankruptcy.  Normally, when an obligation is unpaid or forgiven, the tax code treats the amount of forgiveness as if it were income.  Bankruptcy is the absolute exception and the solution is to file IRS form 982.   You may not recognize Title 11 as the code section for bankruptcy.  It often appears on the 1099 as the exception to the tax.  Just check the first box on the form about Title 11 to exclude this from your income.  There are instructions for Form 982.    You also don’t reduce your basis in property or your home see IRC 1017(c).

Mortgage Forgiveness can lead to 1099 taxable income

The Foreclosure Mortgage Forgiveness Debt Relief Act of 2007 was due to expire on December 31, 2012. But it was  extended to 12-30-2013. The Mortgage Forgiveness Debt Relief Act eliminates any income tax that happens from unpaid debt or debt forgiveness for a mortgage on your primary home. The IRS can assess income tax from a short sale or mortgage modification. Without a Bankruptcy or the Mortgage forgiveness act, any deficiency or unpaid debt will be treated as ordinary income and taxed accordingly. If you don’t meet these criteria consider bankruptcy to avoid a 1099 tax problem. This mortgage exclusion ran out is 2014.

Example: If a property sells in a short sale, deed in lieu, foreclosure, or there is a mortgage modification, and the mortgage company loses 100,000, the mortgagor reports income for 100,000 on a 1099C.

Foreclosure Mortgage Forgiveness Debt Relief Act of 2007

Mortgage modifications and shorts sales are complicated processes.  Homeowners are already struggling. In November 2012, forty-one state attorney generals appealed to Congress, asking that the Mortgage Forgiveness Debt Act be extended. However, it expired. Here are some of the rules of the act.

1. To qualify, you have to use form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. Just attach it to your federal income tax return for the tax year in which the qualified debt was forgiven. A Bankruptcy filed before charging off the mortgage or forgiveness always qualifies for exclusion from income. Just use the first box
2. Under the Foreclosure Mortgage Forgiveness Debt Relief Act of 2007, you may exclude up to $1 million per person of debt forgiveness.  You can have 2 million for a couple, but it must be for your principal residence. Special rules apply.
3. The debt must have been used to buy, build, or substantially improve your principal residence.  That residence must also secure the mortgage.
4. Refinanced debt for substantially improving a principal residence qualifies.
5. Any other purpose, like buying a car, does not qualify for the exclusion.
6. Vacation or second homes, rental property, business property, do not qualify.  The Mortgage Forgiveness  Debt Relief Act or 2007 is an exclusion from the tax provisions as income.
7. As of January 2021 you cannot strip or modify a first residential mortgage in bankruptcy but you can strip or modify a second home rental property or vacation home.
8. If any debt is reduced or eliminated, you will receive Form 1099-C, Cancellation of Debt, from the lender. Refer to form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness.