Your tax preparer will tell you some important things you need to know about cancellation of debt or repossession of property. Undoubtedly, such an experience is filled with stress, worry and a desire for it to be over with as quickly and completely as possible. You would hope after such a negative experience it would end when the cancelation of debt or repossession takes place, never to be seen of or heard of again. However, one day, you may be unpleasantly surprised to find a special little form in your mailbox, silently waiting for you to open it. This obscure and often unexpected little form would be called the “1099-C.”
As your tax preparer will tell you, the arrival of this form can occur far into the future from when the cancellation or repossession event actually happened, which is why it is often an unpleasant surprise for the recipient, who unfortunately did not realize he or she was to expect it. You should be aware that the timing for receipt of this form depends on the process of the specific creditor for the debt in question, and how they handle canceled debt or repossessed property in accordance with their specific policies or business practices.
One factor that comes into play is whether the debt is considered recourse or nonrecourse debt. Recourse debt is (or was) backed by your collateral, and it provides the lender the ability to take back the property that was backing the loan in the case of default. There are instances of full recourse, where you would be liable for the full amount of the loan, regardless of circumstances, where the lender can sell your personal property to fulfill the full amount of debt owed. In the instance of limited recourse loans, however, the lender can take only the personal asset that was provided as collateral on the loan itself, such as with a personal loan where collateral was pledged with personal property, such as a watch or television. With nonrecourse debt, the loan is secured by the asset that is actually financed, generally for long term loans with a high amount. In this case, the lender can only take back the asset upon default and not hold you personally liable as in the case of full recourse debt.
You see, when debt is forgiven or cancelled, the IRS considers it “taxable income.” In other words, while the debt itself may have gone away, it can have an after-effect on your tax return and, consequently, what you owe to the IRS. Therefore, it’s a good idea to consult with your tax preparer to discuss how much of an impact you can expect.
There are some exceptions or exclusions to this process, and again, your tax preparer can walk you through this. For example, if the lender handled your situation by applying discounts or a loan modification, sometimes the treatment is interpreted differently in the eyes of the IRS. If and when you do receive a form 1099-C, however, it means that the event has been reported to the IRS, so of course, you need to incorporate this form into your tax return and your tax preparer can help you ensure you do this the correct way. This “identifiable event” can include anything from bankruptcy, judicial debt relief, foreclosure election, debt relief from probate, an agreement with your lender, among other debt cancellation events that you can check out on www.irs.gov.
Now, we know that the amount of lender forgiven recourse debt must be reported as income to the IRS, but how is this amount determined? In some cases, where a vehicle is repossessed, there can be a deficiency from the amount the lender can sell the vehicle for in relation to what you owed for it. For example, if you owed $15,000 and the lender only sold the vehicle for $10,000, the remaining $5,000 would need to be reported as income on your tax return, where you, in essence will be paying taxes for this forgiven debt, calculated based on your ordinary income tax rate. In addition to this, you may need to report gain or loss of the asset on your report, as well.
As you can see, there are quite a few variables that will affect your outcome, and what you can expect when you are granted cancellation of debt, or when repossession occurs, and the aftermath is not always readily apparent. Hopefully this helps you be prepared, or at minimum, know some great questions to ask your tax preparer.
