What is a 1099-c Form and How Does it Relate to a Foreclosure?

Historically when a homeowner goes into foreclosure and the only resolution is the lender getting back a deed, this likely results in a deficiency between the amounts owed from the final judgment when the property is eventually sold. This "deficient" amount can be handled by the lender in two different ways.

The lender can get a "deficiency judgment" from the court against the homeowner and try and collect this deficiency amount using common collection methods. These methods include attaching assets by court order, garnishment of his pay, working with a collection agency which attempts to get the homeowner to pay, and selling the steeply discounted judgment to someone who believes he can collect the funds within the next 5 or more years.

Homeowners usually have not made mortgage payments for many months before the foreclosure eviction and have "saved" this money somewhere, and this "somewhere" can become a target for the collection agency. The collection agent may have to wait a few years but most often the homeowner is back on his feet in a few years and has money somewhere. This is when it is up to the collection agency to find it and get a court order to collect this money!

In the last 8 – 10 years lenders have not been getting deficiency judgments against homeowners most of the time because in most cases their attitude has been "we can’t get blood from a turnip" because of the homeowner’s financial condition. However, in December of 2007, President Bush signed into law a bill that essentially protects homeowners from having a deficiency judgment issued against them if it is from the foreclosure of their personal residence. But this legislation goes a step further in allowing the IRS to "forgive" the amount of the deficiency judgment issued to the homeowner in the form of a Form 1099-C which is considered as ordinary taxable income to the homeowner.

If the lenders so choose, they issue an IRS Form 1099-C (Miscellaneous Income) to the foreclosed homeowner. This amount was considered ordinary income to the homeowner in that specific year and the amount forgiven was taxable as ordinary income to the homeowner on his tax return. For example, if the lender was owed $200,000 as the final judgment amount and he sells it for $150,000 later, the homeowner is looking at a $50,000 deficiency judgment or his being issued a Form 1099-C in the amount of $50,000. If the homeowner was in the 20% tax bracket, he would owe an additional $10,000 in income taxes that year and payable immediately or with payment terms and interest over a few years.

There is no exception for an investor or homeowner’s second property. So the lender automatically does a search of the credit report of the homeowner to see if he has any other real estate or mortgages he is paying. If the lender concludes that the homeowner has other assets that can be garnished or forfeited to the lender, the lender will get a deficiency judgment and pursue the collection of the final judgment amount.

So if you are a homeowner in foreclosure you can expect to have the deficiency amount "forgiven" by the IRS through the end of 2009. However, if you are homeowner who has investment property, you should take action to secure this property from creditors before you go into foreclosure. Again, consult with a local attorney to see what your rights are in your state.