1099-A In the Mail? (con’t.)
The difference between the principal listed in Box 2 and the Fair Market Value listed in Box 4, is the amount on which you may owe taxes.
Let’s say, for example, Box 2 lists $100,000 as the principal outstanding. If the FMV in Box 4 is $50,000, then the difference is $50,000, and that amount will be included in your taxable income, unless you qualify for an exclusion or exception. If Box 4 lists the FMV as $80,000 instead, then the difference is only $20,000, and your tax liability could be significantly less.
Karla Dennis, CEO of Cohesive Tax, suggests checking the FMV using an online website like Zillow, or getting an appraisal. In the case of auto repossessions, she suggests using Kelly Blue Book to research it.
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According to the TaxMama website, “While the IRS presumes the FMV amount to be correct as shown on the 1099, you can dispute the amount if you provide information from reliable sources that support the amount you assert as the true value.”
The next box to take a look at is Box #5. It shows a checkbox with the statement: Check here if the borrower was personally liable for repayment of the debt.
If this box is not checked, and you are not personally liable for the loan, then you may not have to worry about including it in your income. “This is your ticket out of hell,” says Purdy. He practices in California, where certain loans do not cause borrowers to be personally responsible for the debt. However, he warns that this box is “routinely mismarked.” If you’re not sure if that box has been marked correctly, check with an attorney experienced with both real estate and tax matters.
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So what if this form indicates income due to forgiven debt? As I explained in my previous article about Form 1099-Cs, you may be able to reduce or eliminate any tax liability on this income if you qualify for an exclusion or exception.
In the case of foreclosures or short sales, the most commonly used exclusion is found in the Mortgage Debt Relief Act of 2007. This law generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring (for example, a loan modification that includes a reduction in the principal owed), as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
If you qualify, the exclusion applies to up to $2 million of forgiven debt, ($1 million if married filing separately), and only for debt forgiven in calendar years 2007 through 2012 .
There are some important caveats here. You don’t get this break on second homes or investment properties. And it does not apply if your debt was forgiven for any reason not directly related to a decline in the home’s value or your financial condition.
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It also doesn’t include loan amounts used for any reason other than to buy, build or substantially improve the property. This isn’t usually an issue if you took out your loan to purchase your home, but if you refinanced your home, you could run into problems if you used the proceeds for other purposes.
For example, if you refinanced your home and took money out to pay for your children’s college tuition, or to consolidate debt, this exclusion would not apply to that portion of forgiven debt. “People who repeatedly refinanced and used the money for other things have the hardest time of all,” says Purdy.
However, all is not lost if you don’t qualify for this exclusion. You may still be able to avoid paying federal taxes on your debt if you are considered insolvent. I discussed how that calculation works in my previous post: How can I avoid paying taxes on a 1099-C? The insolvency exclusion can significantly reduce, or even eliminate, the taxes you’ll have to pay.
“Timing is everything,” warns Purdy. “Get advice before the short sale or foreclosure occurs because by the time that 1099 is issued it may be too late to use all of your options.” His analogy? “You need to get a flu shot before flu season. By the time you’ve got the flu, it’s too late.”
Learn more: Read A Slew Of Tax Tips To Clean Your 1099-C Mess