Have a Tax Question? Ask a Tax Expert
This area of the tax law is extremely complex and you should locate a CPA that knows how to deal with this type of situation if you cannot get your arms around the the tax law. I can give you a lot of information that will help you understand the process and hopefully get you started with your alternatives. Many of the alternatives depend on your fact patterns of your current situation.
It is important to note that a 1099-A is different than a 1099-C in that a 1099-A (Abandonment) requires the taxpayer to calculate a gain/ (loss) on the transaction. If it is a gain, they will report the gain on Schedule D of the IRS Form 1040. If it is a loss, it becomes a non-deductible loss. A 1099-C is similar, however, this is when the bank has concluded its proceedings for collections and has determined that they will forgive the indebtedness. You will want to read more on these forms in the attachments that follow.
One method is to prove insolvency. This area is subjective in some areas such as vehicle fair market value and other valuations of assets. However, you home values and debts outstanding as related to the forgiveness of debt are sometimes stated on the 1099-C. This too is discussed in the links below:
IRS Form 982
Also, take a look at IRS Publication 4681
You will need to make sure you are following the instructions related to the forms and publications with great detail.
The following article located on the IRS website discusses the new Mortgage Forgiveness Debt Relief Act and Debt Cancellation Act that helps taxpayers in this situation. It is important to note that the state of California does not conform to this law at this point. However, the state does have some pending legislation to provide relief. No one knows if it will pass.
If you choose to utilize the IRS Form 982 and the insolvency option, you will need to make sure you go through each test.
See the below example taken from the IRS Publications as to how an individual's was able to utilize the insolvency rules:
Example. In 2004, Kyra bought a car for personal use. The cost of the car was $12,000. Kyra put down $2,000 and took out a loan of $10,000 to help with the purchase. The loan was a recourse loan, meaning that Kyra was personally liable for the full amount of the debt.
On December 7, 2007, when the balance of the loan was $8,500, Kyra was unable to make payments and the lender repossessed the car. The car had a FMV of $7,000 at the time of repossession. At the time of the repossession, the lender forgave the remaining $1,500 balance due on the car loan ($8,500 outstanding balance immediately before the repossession minus $7,000 FMV).
Kyra's only other assets at the time of the cancellation are the furniture in her apartment which has a cost basis of $5,000 and a FMV of $3,000, jewelry with a basis of $500 and a FMV of $1,000, and a $600 balance in her savings account. Thus, the FMV of Kyra's total assets immediately before the cancellation was $11,600 ($7,000 car plus $3,000 furniture plus $1,000 jewelry plus $600 savings). Kyra also had an outstanding student loan balance of $6,000 immediately before the cancellation, bringing her total liabilities at that time to $14,500 ($8,500 balance on car loan plus $6,000 student loan balance). Other than the car, which was repossessed, Kyra held all of these assets at the beginning of 2008. The FMV and bases of the assets remained the same at the beginning of 2008.
Kyra received a 2007 Form 1099-C showing $1,500 in box 2 (amount of debt canceled) and $7,000 in box 7 (FMV of the property). Kyra can exclude all of $1,500 canceled debt from income because at the time of the cancellation, she was insolvent to the extent of $2,900 ($14,500 of total liabilities immediately before the cancellation minus $11,600 FMV of total assets at that time).
Kyra checks box 1b on Form 982 and enters $1,500 on line 2. Kyra enters $100 on line 10a (the smallest of: (a) the $5,500 bases of Kyra's personal use property held at the beginning of 2008 ($5,000 furniture plus $500 jewelry), (b) the $1,500 amount of nonbusiness debt she is excluding from income on line 2 of Form 982, or (c) the $100 excess of the total bases of the property and the amount of money Kyra held immediately after the cancellation over Kyra's total liabilities at that time ($5,500 bases of property held immediately after the cancellation plus $600 savings minus $6,000 student loan).
Kyra must reduce her bases in her property in proportion to her adjusted bases in the property. Thus, Kyra reduces her basis in the furniture by $ 91 ($100 × 5,000/5,500) and her basis in the jewelry by $9 ($100 × 500/5,500).
This should give you a good start to understanding this process.
If you have any questions, please do not hesitate to contact me.