Warning There Is A Hidden Trap In Debt Forgiveness You Must Be Aware Of
Have you recently negotiated or thought of negotiating a forgiveness of debt? Before you do so, beware of the catch behind it! Forgiveness of debt converts to ordinary income and can be taxable. Don’t be that person uttering the word “oops!” when you unexpectedly become aware in January that all along there was a catch.
A major focus of our services is to provide clients with a debt workout, SBA loan forgiveness, and bank debt forgiveness of debts owed. Fortunately, we have negotiated hundreds of millions of dollars of debt forgiveness and comprehend the issues and concerns. Thereby, I can provide you with the following warning: The IRS considers debt forgiveness “ordinary income.” This can be risky because instead of being left with a substantial debt owed to a bank (or whichever was the original source), you are now left owing the IRS making the situation a lot like the proverbial “jumping from the pot into the fire.”
Owing the IRS can be a daunting and very expensive experience. Interest and penalties can be vast and compound rapidly. Here is an example of how debt forgiveness can be painful to your very own pockets. If a few borrowers guarantee a loan for a million dollars and decide to negotiate forgiveness for the entire amount, the IRS will deem each guarantor liable for the full million dollars. If the debt forgiveness is granted, it will denote that each borrower will be responsible for $300k- $400K of debt owed to the IRS.
A variety of approaches exist that can eliminate the threat of conversion of debt forgiveness into ordinary taxable income. Although some strategies are difficult to incorporate, they are efficient and should very well be considered. Luckily, the most common way around this issue is simple and practically automatic. It is of course, on the basis of each particular circumstance. However, the key to this issue is that one must first be aware of the problem in order to find a resolution for the issue as well as addressing the concern of your original debt.
The Mortgage Forgiveness Debt Relief Act of 2007 is one that exempts you from a certain situation. As stated therein, debt forgiveness associated with your principal place of residence is NOT subject to be treated as ordinary income through the forgiveness of debt 1099. Such exclusions also include refinancing or selling your principal place of residence. There are various other approaches with exclusions that can have broad applications to numerous borrowers.
If your loan workout representative fails to address this issue with you, then perhaps they are inexperienced in this area. You may want to consider finding someone a bit more qualified to deal with issues such as these. Many times, individuals also encounter agents who will make them aware of the problem, however will not provide a proper solution. Again, my suggestion is to find someone who is experienced in handling these issues. If you find yourself confronting this problem, and your agent is ineffectively representing you, give us a call. Contact us prior to resolving the debt otherwise, it may be too late.
Forgiveness of debt can lead to important results and is available for an SBA loan in default. However, it is a highly important matter. Don’t allow just any professional deal with this affair. Ensure that your issue is taken up by a specialist who can truly resolve it.
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Yep – There’s always a raised eyebrow when people find out that debt savings also equals tax payings! But hey – just like in getting a paycheck, you receive a lot more in income (or debt savings, in case of a settlement) than you pay in taxes.
Generaly speaking this is true and I agree with your statement, however there are many times I have negotiated the reductiion of debt worth a million or more and the taxpayer is left with a huge debt to the IRS which is a very difficult position to be in, so this issue must be considered very seriously when the debt forgivenesss is significant and there is no cash to pay the tax.
Don
what about debt forgiveness for student loans for people employed in the public service sector (for me, being a public school teacher). After 10 years of public service during your repayment, your remaining interest and principal balance are forgiven. If around $70,000 is forgiven, what would I end up owing the IRS?
While termed debt forgiveness, it is not the type of forgiveness that triggers ordinary income as it is in consideration of your commitment to teach. Thus it is not a taxable event. Nice work, thank you for being willing to the work you do, we all benefit from it.
don
I had a business that closed last year. The company is an LLC and had a debt forgiven. The company showed an operating loss and was insolvent – but not bankrupt. Would the debt forgiveness flow through as ordinary income? Wouldn’t this qualify as an exception from ordinary income since the business that had the debt was insolvent?
I am Captain Thomas Ross, a military reservist deployed to KOSOVO. I own a medical company which has recently loss over $800,000 in business. To compound matters, I have a $100,000 tax lien on my primary resdence. Is there anyway to have this tax lien lifted so I can borrow government emergency funds to pay off the monies which I owe the IRS?
Yes there is, its a buit complicated and requires some effort but there is a procedure…why not an offer in compromise? Is the business going to surgvive your absence?
Who is running it in your absence, thats allot of cash to lose…
There is probably alot I can do for you and am willing however how will we communicate, as I need lots more information. can you call me or can we do it via email we need to have a conversation.
I respect the sacrifice you are making for our country and would be glad to assist you for no charge. Your paying enough for our collective well being, allow me to repay you a bit.
Don 413-687-8388
I AM PART OF AN LLC THAT OWNS LAND IN AZ. I WAS TOLD THAT THE LENDER WILL ACCEPT A REDUCED PAYMENT IF OUR LLC SUBORDINATES TO ANOTHER INVESTMENT SOURCE. WILL I HAVE TAX CONSEQUENCES ON THE C O D?
I would ned more info to answer , however if you are personally guarenteed on the obligation, and theeir is debt forgiveness then the bank could issue you a 1099 indicating a conversion to ordinary income…thats the key, However if you are secondarily obligated after the LLC, which is then a contingent liability you may escape such treatment…check with your accountant he will havbe the details and can better anser you. But you are smart to be aware of this issue and possibly negotiate a better result if you are to be held personally liable and thus forgiven debt a tax problem. Either way the forgiveness is worth lots more then the potential tax and there are other ways to reslve this issue safely without 1099 debt forgiveness conversion.
don
I am a single woman who has worked very hard for many years and now my home almost payed off. Because of the economy my income has drastically been reduced over the last couple of years. I am thrifty, sensible and manage to somehow pay my bills and debts. I am very offended that there are people out there obviously living beyond their means and being FORGIVEN their debt! What do I get for working and actually paying my debts? Their debt? Where does the forgiven debt come from? Is it ME, because I’m having a hard time just paying for me and disgusted at the freeloaders. where is my reward? I feel like taking a vacation or 2 on credit, maybe I’ll buy a new car, new windows for my home, turn the heat up and more and why not if I can just have it forgiven? please explain to me my reward for being responsible. Look forward to an answer, Laura
Interesting blog, I’ll try and spread the word.
Hi Donald,
We were forced to leave of our home 2 1/2 years ago because of what is now called a sub-prime mortgage. . We had no idea that was what we were getting into, and when we were at the signing, we realized all the lies we were being told and should have walked away. The payments were increasing $300.00 every quarter, and after working to try to save our home for over a year, we had to leave it, leave Colorado, etc. Almost immediately, we put our home up to sell, and then the CO housing market began to collapse. We couldn’t sell, the mortgage company wouldn’t work with us, it was a nightmare and we have suffered for over 4 years now. Long story short, the house was foreclosed on in 2007 and then resold, and the 2nd was forgiven (It was not a line of equity, but actual 2nd mortgage on our primary residence). We just received in the mail a letter from Carrington Recover Services, LLC, A collection service for Deutsche Bank National Trust, saying that we owe them $175,000.00. How can this be? We are going to get an attorney and write a letter of dispute, as well as try to get this to stop for others. They are reselling invalid debt and it has to be against the law.
I read your blog for quite a long time and must tell that your articles always prove to be of a high value and quality for readers.
Question regarding 1099. My business asset has been liquidated and deficiency is more than 200K on SBA loan. Suppose, if they write off then Can the bank or SBA send me 1099 even though my business has no assets and I personally do not own any real estate?
I am real estate broker and my daughter is short selling 3 properties in San Diego area
She is also getting married on 5/2 and is concerned about her new husband’s liability after they marry….one property living in will have around $300K debt being reduced…another about 200K and third one already closed had about 250K reduction….will lenders report this and is this only way for IRS to find out???
and what can be done with pre nupt to protect this….and my daughter will be insolvent and has been for since last august of 08….can she complete these sales and not be at risk for IRS to come after her for lots of $$$ for long time….concerned dad
First there are definite ways to avoid the issue of 1099 tax for conversion of forgiveness of debt to ordinary income.
Once done the issue is gone.
Here is the answer: the 2007 law says that if one is insolvent at the time the forgivness is granted then the conversion does not occur and their is no ordinary income. Any respectable accountant will know how to file this as there is a specific form for it.
That will resolve the issue and free your daughter to mary and live happlily ever after…I hope.
Don
Hi Donald
I purchased a lot in a development 3 years ago. The development has ceased and the lot value is 1/3 of what I paid. The bank has offered a $200k Settlement (as payment in full) on my $550k balance. My concern is the 1099 and associated ordinary income tax. I gather that I should expect to be 1099′d on the $350k forgiveness of debt. Can this qualify as investment income vs ordinairy income? Also, the $600k lot is now worth $200k. Can that be considered a loss to write-off against the “forgiveness”?
Hi,
My wife and her partner own a business we are thinking of closing as I am moving. We all had given personal gaurantee towards this SBA loan. One partner is in CA we are moving to NY and the business is in WI. Across all of them I am the high wage earner like $140k. But as I have given personal gaurantee I might be a target from the bank for this. Both wife (not received any wage from business) and her partner are not earning much.
Is offer to compramise and/or business bankruptcy better way? I have high wage and residual income is up to $2k. The loan due is around $125k.
Thanks lot for your advice.
definitely offer in compromise, but you must prepare for this and need a strategy to get the best results, call us at 413-584-2581, we can discuss a possible plan. Don
Hi Donald,
I have a investment property that never got developed, only land, and we’re reaching the point of foreclosure. When I brought up the 1099 issue with a law firm specializing in debt foregiveness/reduction, they said not all banks issue out 1099s, which I found very unlikely since the bank has a responsibility to report lost income. Would there actually be a reason(s) for a bank not to issue me a 1099, on the forgiven portion, knowing that I’m not insolvent?
Kenny
are you certain you are not insolvent? It does happen on occasion, the banks agreeing to not report the forgiveness of debt, but there may be a better strategy here, call to discuss. 413-584-2581
I defaulted on two mortgages in 2000 in CA. The lender foreclosed the property in 2001 and lost ~$100k on both defaults. I’ve been living abroad since then and haven’t been filing US tax returns. Now I’m seeing two tax liens on my credit report with liabilities totaling ~$100k.
1. Is this a case of debt forgiveness converted to ordinary income? If so, how come the total tax liabilities equal total income unreported?
2. What’s my best course of action? Are you a tax attorney? If so, can you represent me in dealing with the IRS and CA Franchise Tax Board? I’m willing to pay the liability in installment if they agree to abate the interest and penalty. I don’t mess with the taxman. How much do you charge for your services?
Thanks.
I own a home in Phoenix that I have been renting out since 2005. If I let it go into foreclosure and the bank issues a 1099C, it will be for about $124K (ordinary income).
It so happens that the difference between my adjusted basis(after depreciation taken)=$203k and the fair market value of the property=$79k is negative $124k. Wouldn’t I be able to take this as a Section 1231 ordinary loss and cancel out the ordinary income from the cqncelled debt?
Thanks!
I have a small company. My company owe one of our vendor 1,500 and the State Controller $650 in Sales Taxies. Can my company ask for a forgivines and not be have to pay IRS taxeies. my company is not a llc or corp.
It is unlikely that a 1099 would be sent to you from a vendor, don’t worry.
I owe the SBA bank $172k, I had to close my business due to it was losing money at a rapid rate. I have not yet defaulted on ANY of my loans. The primary mortage is $122k, HELOC about $12k, then the sba is 3rd leinholder on my home. I got a letter from the sba bank to my mortgage company telling my mortgage bank the sba now holds the deed. I’m assuming this means they are getting ready to foreclose on my home? The value of my home is approx $320k, which would leave equity of about $150k give or take. I understand the sba has to pay off the first 2, then try and sell my home for their recoup. Is there anyway to negotiate a settlement for much less and prevent them from taking my home? I don’t have it to pay them unless i liquidate my IRA’s which I have no intention of doing. Can tey attach any personal assets (bank accounts, stocks etc)?
The band I am in (an LLC) borrowed $50k from my mother in 2006-2007 for production of a CD. We intended to pay her back based on sales but that has not happened. We paid some principle and interest. The debt is now $40K but it is highly unlikely we will be able to pay the full amount. She is fine with forgiving any or all of the debt. Does this mean that we would have to claim $40k as income to the LLC? Most likely, she will claim the forgiveness as a bad debt loss for her own purposes but will not send us a 1099.
Thanks for your help.
Not a problem. Consider it a gift from your mother. No 1099 no conversion to income.
I am 1/3 partner in an LLC that owns 4 rental properties. The LLC is under water and the bank is foreclosing on the loans. Which is better from a tax point of view?–allowing it to go to foreclosure and the bank getting the properties after the 6 month redemption period or letting the bank have the properties in a deed in lieu scenerio right away. Is one better than the other? The key fact is that the LLC has a negative equity posisiton. Also is bankruptcy of the LLC advised or necessary?
Thanks Doug
Hello,
I just refinanced my house with a debt reduction of $45k. I was told by the bank representative that I would get a 1099 for the debt forgiveness. With the Mortgage Debt Forgiveness Relief Act of 2007, will I have to add as ordinary income in 2010 or not. I’m getting confused on some of the wording…
Above, you state, “As stated therein, any debt forgiveness associated with your principle place of residence is NOT subject to 1099 ordinary income treatment! This includes debt forgiveness from refinancing or selling your principle place of residence and is a very important exclusion.” But I have read other websites that state I must prove I am insolvent to not add to ordinary income. Which is correct?
Thank you for your assistance.
I’m dissolving an LLC (treated as a Corporation for tax purposes) which I co-own with my wife.
We gave a $3k loan to the company and we are planning on forgiving that debt prior to dissolution.
Do we need to give the company a 1099 and treat the forgiveness as other income in our 1120?
Thanks, great blog!
Sebastian
I just graduated and now have about $150,000 in school loans (Subsidized, Unsubsidized and private) to pay for both tuition and living expense. Now with no job in this lovely economy, I’m tempted to try a one of those Debt Relief programs. What do you know about those programs? Good idea or will I end up owing the IRS because of it? Thanks!
Question:
I personally Guaranted a Real Estate debt of an LLC. The property was foreclosed and lender took it over in creditor bid at Foreclosure Auction. Lender issued 1099-C and cancelled the Debt of LLC, the original borrower while suing me personally for Guaranty given. Is the Guaranty is still valid if Debt for which Guaranty was given is cancelled.
Naresh, yes.
I admit that I too have had similar thoughts but I end with a feeling that my self sacrifice, my pride in my accomplishments and comfort in the fact that I have to judge myself, and I am satisfied with what I have accomplished and thus am confident I have lived an honorable life, doing the right things and reaping the benefits… are my rewards, Frankly those are my standards and what others do or do not do is not very relevant to what my assesment is of my accomplishments, my life and the standards i choose to live by.
We are our own judges…It appears to me that you have earned the right to be satisfied with your self…that should be enough. What others do is their issues not yours.
You are your own judge. What you have accomplished , which is clearly formidable, how you lived your life, what your standards are and how well you reached oyut to live by them are your benchmarks. In the end it would appear to me that you should be proud of your accomplishments and satisfied with your life effort…what more would you ask for?
thank you, I hope it helps someone.
Good luck, I hope it works out well. Many strange things occur in this debt ridden world. Persevere.
Of course they can send you a 1099, however they will not because it was he business that defaulted on the debt you are merely the guarantor no the debtor, additionally if insolvent at he time of forgiveness the forgiveness of debt does not convert to ordinary income and is not taxable.