Foreclosure ATG - Chapter 7 – Form 1099-A and Form 1099-C
Publication Date - February 2015
NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
- Examination Considerations
- Inaccurate or Questionable Forms 1099-A and 1099-C
- Form 1099-C Box 2. Amount of Debt Discharged
- Form 1099-A Box 4 & and Form 1099-C Box 7. Fair Market Value (FMV) of Property
- Form 1099-A & Form 1099-C Box 5. Check here if the Debtor was Personally Liable for Repayment of the Debt
- Form 1099-C Box 6. Identifiable Event Code
A lender must follow the reporting regulations that determine when a Form 1099-A and/or Form 1099-C are issued to the borrower. Treas. Reg. §1.6050P–1 governs the information reporting for discharges of indebtedness by certain entities. The instructions to Form 1099-A and Form 1099-C provide an overview of these rules.
A debt is deemed to be discharged for information reporting purposes only upon the occurrence of an identifiable event specified under Treas. Reg. §1.6050P–1(b)(2), whether or not an actual discharge has occurred on or before the date of the identifiable event. See Treas. Reg. §1.6050P–1(a)(1).
An identifiable event under Treas. Reg. §1.6050P–1(b)(2)(i)(H) has occurred during a calendar year if a creditor has not received a payment on an indebtedness at any time during a testing period (as defined in Treas. Reg. §1.6050P–1(b)(2)(iv)) ending at the close of the year. The testing period is a 36–month period increased by the number of calendar months during all or part of which the creditor was precluded from engaging in collection activity by a stay in bankruptcy or similar bar under state or local law. The presumption that an identifiable event has occurred may be rebutted by the creditor if the creditor (or a third-party collection agency on behalf of the creditor) has engaged in significant, bona fide collection activity at any time during the 12–month period ending at the close of the calendar year, or if facts and circumstances existing as of January 31 of the calendar year following expiration of the 36–month period indicate that the indebtedness has not been discharged. Treas. Reg. §1.6050P–1(b)(2)(iv) further states that, significant, bona fide collection activity does not include automated mailings, but does include a lien against the debtor. Under Treas. Reg. §1.6050P-1(b)(2)(i), identifiable events, in general, are summarized below:
- A discharge of indebtedness under bankruptcy;
- A cancellation or extinguishment of an indebtedness that renders a debt unenforceable in a receivership, foreclosure, or similar proceeding in a federal or State court;
- A cancellation or extinguishment of a debt upon the expiration of the statute of limitations for collection of a debt;
- A cancellation or extinguishment of an indebtedness pursuant to an election of foreclosure remedies by a creditor that statutorily extinguishes or bars the creditors right to pursue collection of the indebtedness (e.g., non-judicial foreclosures in some states);
- A cancellation or extinguishment of an indebtedness that renders a debt unenforceable pursuant to a probate or similar proceeding;
- A discharge of debt pursuant to an agreement between an applicable entity and a debtor, to discharge indebtedness at less than full consideration (e.g., short sale);
- A discharge of debt pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge debt; or
- In the case of an entity described above in (A) through (C), the expiration of the non-payment testing period.
The first seven identifiable events are specific occurrences that typically result from an actual discharge of indebtedness. The eighth identifiable event, the expiration of a 36-month non-payment testing period, may not result from an actual discharge of indebtedness. Due to debtors' confusion regarding whether the receipt of a Form 1099-C represented cancellation of debt income under the 36-month non-payment testing period, the Treasury Department and IRS issued Notice 2012-65(2012-52 IRC 773 (Dec. 27, 2012)), and requested comments from the public. Several commentators recommended either the removal or revision of the 36-month rule.
The Treasury Department and IRS agree that the information reporting should generally coincide with the actual discharge of a debt. The Department of the Treasury and the IRS are concerned that the 36-month rule creates confusion for taxpayers and does not increase tax compliance by debtors or provide the IRS with valuable third-party information that may be used to ensure taxpayer compliance. Consequently, in October 2014, the IRS issued proposed regulations to remove the rule that a deemed discharge of indebtedness for which a Form 1099-C, Cancellation of Debt must be filed occurs at the expiration of a 36-month non-payment testing period. The proposed regulations will affect certain financial institutions and governmental entities. See 79 FR 61791-01, 2014 WL 5144724 (F.R.).
Generally, the Service may rely on the Form 1099-A and Form 1099-Cs that are issued to taxpayers. Nevertheless, as previously discussed, the issuance of a Form 1099-C solely due to the 36-month testing period may create challenges during the examination. Secondly, as discussed later, an examiner may encounter inaccurate forms. Sometimes, a taxpayer is not issued a Form 1099-A or C on subordinate loans or the taxpayer may not be issued a Form 1099-C on either loan. This does not relieve the taxpayer from reporting the CODI.
The determination of whether discharge of indebtedness has occurred is factual and often the subjective intent of the creditor as manifested by an objectively identifiable event (Kleber v. Commissioner, T.C.Memo. 2011-233 at *3). The issuance of a Form 1099-C is an identifiable event, but it is not dispositive of an intent to cancel indebtedness. For example, in Kleber v. Commissioner, supra, although the creditor issued the Form 1099-C for the debtor-taxpayer's 2006 tax year, the court found that the discharge of the taxpayer's indebtedness had occurred during her 2002 tax year. Therefore, the Service can assert that a taxpayer's indebtedness has been discharged for the tax year it became clear that a debt would never be repaid, even if the creditor did not issue a Form 1099-C for that year.
The court decided in Rinehart v. Commissioner (T.C. Memo. 2002-71) that although Ms. Yeager did not receive a Form 1099-C, the facts led the court to believe that the debt was forgiven and this amount should have been included in income. The court relied on Cozzi v Commissioner, 88 T.C. 435, 455 (1987) and Vaughn v Commissioner, T.C. Memo. 1992-317, affd. without published opinion 15 F.3d 1095 (9th Cir. 1993) and stated,
"When it becomes clear that a debt will never have to be paid, such debt must be viewed as having been discharged, creating income to debtor, and receipt of Form 1099-C from the lender is not determinative…Non receipt of a Form 1099 does not convert taxable income into nontaxable income."
It is important to identify all loans on the property to determine the correct gain or loss and CODI. A review of property information, county recorder documents, Forms 1099 (e.g., including prior and subsequent years of examination), Schedule A mortgage interest, and/or loan documents should be made.
The following facts and circumstances should be considered to determine whether the taxpayer has cancellation of debt income when a taxpayer is not issued a Form 1099-C:
- Identification of whether the loan was recourse or nonrecourse.
- The sale was completed.
- Lender was awarded a deficiency judgment.
- Collection activity taken against the taxpayer other than phone calls and letters.
- Governing state law of where the property is located.
When the real estate market crashed there were several news stories about taxpayers who were not aware of the tax consequences of their foreclosed property, especially if they did not receive a Form 1099-C. State foreclosure laws govern foreclosure proceedings and actions that can be taken after a foreclosure. For example, if a lender pursues a non-judicial foreclosure proceeding, the lender will not be allowed to pursue a deficiency judgment in some states. Therefore, if the taxpayer was not issued a Form 1099-C, it is important to understand the governing state law where the property is located and the actions taken by the lender to determine the CODI amount, if any. Facts and circumstances will determine when the cancellation of debt should be reported. Kleber v Commissioner, T.C. Memo. 2011-233, provides guidance on the application of the rules in Treas. Reg. §1.6050P-1.
In light of IRC §6050P, a question arises as to whether debt is discharged for purposes of IRC §§ 61(a)(12) and 108 when a borrower has not made a mortgage payment for at least 36 months. Whether a debt has been discharged is dependent on the substance of the transactions (Cozzi v. Commissioner, 88 T.C. 435, 445 (1987)). The moment it becomes clear that a debt will never be repaid, the debt must be viewed as having been discharged. The test for determining such moment requires a practical assessment of the facts and circumstances relating to the likelihood of repayment. Any "identifiable event" which fixes the loss with certainty may be taken into consideration (United States v. S.S. White Dental Mfg. Co. of Pennsylvania, 274 U.S. 398 (1927)). The court stated that the mere fact that a mortgagor has not made a payment for 36 months does not mean that the debt has been discharged.
IRC §6050P and its regulations do not apply for determining whether the debt has been discharged for purposes of IRC §§61(a)(12) and 108. The limitation to eight identifiable events and the rebuttable presumption for a 36-month non-payment period under Treas. Reg. §1.6050P-1(b) apply only for purposes of determining the creditor's obligation to issue a Form 1099-C, Cancellation of Debt. For purposes of IRC §§61(a)(12) and 108, the determination whether debt has been discharged requires a practical assessment of the facts and circumstances relating to the likelihood of payment.
If audit adjustments are made to include CODI, oral testimony from taxpayers may not be enough factual development to support an adjustment, especially if the case is unagreed. In some states, the lender will publicize the foreclosure notice and record the notice of default with the County Recorder's office. The case file should include documentation to support the Government's position. An explanation of each supporting document should be addressed to strengthen the Government's position. For example, a copy of the deed or closing escrow documents will indicate dates, amounts, any monies given to the seller (homeowner) which are needed for the calculation of the gain/loss.
A Form 1099-A is issued when there is an identifiable event. For example, the date when the lender becomes aware the property was abandoned or the date of the foreclosure, short sale or deed in lieu of foreclosure. A Form 1099-C will be issued when the property is sold, in a foreclosure sale, for example, and the lender discharges some or all of the outstanding debt. A chart with the identifiable codes is located in Publication 4681.
Example 34. Marion's property was foreclosed in 2010 and the lender issued a Form 1099-A. The lender did not sell the property until 2013 and issued a Form 1099-C at that time. The year of the disposition would depend on the 1) type of loan and 2) state law of where the property is located.
Inaccurate or Questionable Forms 1099-A and 1099-C
Audit techniques are identified below when a Form 1099-A or Form 1099-C is issued with questionable information. Common situations follow:
Form 1099-C Box 2. Amount of Debt Discharged
Total debt includes total amount owed to the lender, including stated principal, stated interest, fees, penalties, administrative costs, and fines. Prior to 2014, the IRS instructions for Forms 1099-A and 1099-C instructed the filer not to enter any amount the lender received in satisfaction of the debt by means of a settlement agreement, foreclosure sale, etc…
Since there is a possibility that this amount does not include any consideration received, it may create a problem in identifying the actual amount of the discharged debt for tax purposes. For example, a foreclosure sale resulted in discharge recourse debt of $30,000. However, the lender entered $50,000 in Box 2 which does not include consideration received from the foreclosure sale.
The loan documents or last mortgage statement or settlement agreement letter (ie; short sale) and closing escrow documents along with the Form 1099-A and/or Form 1099-C may help to determine the loan balance and amount forgiven at the time of the disposition.
Form 1099-A Box 4 & and Form 1099-C Box 7. Fair Market Value (FMV) of Property
Prior to 2014, the IRS instructions for box 7, FMV of Property, did not address short sales and stated:
"If you are filing a combined Form 1099-C and 1099-A for a foreclosure, execution, or similar sale, enter the FMV of the property. Generally, the gross foreclosure bid price is considered to be the FMV. If an abandonment or voluntary conveyance to the lender in lieu of foreclosure occurred, enter the appraised value of the property."
A lender generally will conduct an appraisal prior to the short sale of property and the FMV should be known. However, the IRS has noted that some Forms 1099-C have been issued with a zero FMV amount. Under these circumstances, the amount realized in a short sale is the sales amount.
Form 1099-A & Form 1099-C Box 5. Check here if the Debtor was Personally Liable for Repayment of the Debt
The IRS instructions for Forms 1099-A and 1099-C provide, "If the debtor was personally liable for repayment of the debt at the time the debt was created or, if modified, at the time of the last modification, enter an "X" in the checkbox".
Box 5 does not specifically instruct the lender to identify whether the loan itself was recourse or nonrecourse, but rather whether the borrower is liable to repay the debt. If the lender has decided to forgive the outstanding debt, the borrower is technically no longer liable. As such, the instruction may be interpreted as the borrower is no longer liable for the outstanding debt through a short sale and, therefore, the box is not checked.
The loan documents will identify whether the debt was recourse or nonrecourse. Some states may identify the original loan as nonrecourse and if the loan is modified, it becomes recourse.
- Obtain a copy of the loan documents to determine whether the loan was recourse or nonrecourse. Look for language such as power of sale that explains the actions that a lender may take if the borrower defaults on the loan.
- If the taxpayer no longer has the records, summons the lender for a copy of the loan documents.
- Seek assistance from local Counsel for specific state law questions.
Form 1099-C Box 6. Identifiable Event Code
Box 6 may be left blank by a lender. The instructions are very self-explanatory, "Enter the appropriate code to report the nature of the identifiable event…" However, a lender may conclude that a short sale does not qualify as an identifiable event. Short sale should be included as an identifiable event F, "A discharge of indebtedness under an agreement between the creditor and the debtor to cancel the debt at less than full consideration."
During the initial interview, ask the taxpayer or representative the facts and circumstances regarding canceled debt. The type of disposition will help to identify any additional documents to request.