If you have to surrender your home in a Chapter 7 Bankruptcy, the mortgage lender will provide you with a 1099-C. When you file a Chapter 7, the tradeoff is that the mortgage debt is completely dischargeable but you cannot keep your home.
Another tradeoff is that when the mortgage debt is forgiven, the IRS views the forgiven amount as income. So, homeowners do not have to pay the remainder of the mortgage but the amount forgiven is taxable income.
When a debt is forgiven, the IRS requires that the lender provide the borrower with a 1099-C form. The borrower is then required to file the 1099-C with the IRS. The 1099-C represents income from the cancellation of a debt.
One way to explain the form is that a 1099 is used to report income earned from a job. Form 1099-C reports income made from the cancellation of a debt. When the loan is made, the borrower makes a promise to pay and the lender receives a secured interest in the property. At the time the loan is made, the money is not considered income because the borrower promises to pay the money back to the lender. When that promise to pay is discharged, the IRS views the forgiven amount as taxable income.
You may be wondering how you will pay the taxes on this income if you have filed bankruptcy. You filed because you do not have enough money to pay your bills. Where are you supposed to get the money to pay the taxes on this income?
The good news is that in 2007, The Mortgage Debt Relief Act of 2007 was passed. As a result of this Act, taxpayers can have up to $2 million of mortgage loans forgiven before being taxed. According to the IRS website, this Act will be in place through the end of 2013. It is important to realize that this Act only covers debt forgiven for a mortgage. If you have debt forgiven from another type of loan, you will receive a 1099-C for that loan and you will be responsible to pay the applicable taxes.
If you do not understand your 1099-C or believe there is an error, start with contacting the lender. Other options are to contact the IRS or speak with your bankruptcy attorney.
What About a Second Mortgage?
Writing Off or “Charging Off” Your Second Mortgage & Putting it into Bankruptcy
Every expert says the same thing. A “charge off” is the same as a “write off” and is merely an accounting term used in financial processes. The term is used when a financial institution takes an account from a ledger and posts it to that financial company’s “unable to collect” ledger. The lien from the mortgage still exists on the property owner / debtor’s credit report. The monies owed at the time of the “charge off” are still owed. The financial company is simply waiting to decide its next move. It is simply not going to continue trying to collect on a loan that the debtor is unwilling or unable to pay. The fallacy believed by too many debtors is that they no longer owe anything on this “charged off” mortgage. On the contrary, that mortgage company is just standing still, waiting low. The company knows the financial conditions of the debtor and the primary mortgage. The company does not want to foreclose because, as is likely, the primary will get all of the monies from the sale, leaving nothing for this company. So, again, they do not want to force foreclosure. If they get tired of holding this uncollectable debt, they may sell it off to a collection agency. At that point, this original financial institution no longer cares. By law, they have to remove their lien within sixty days or face being sued by the debtor.
If in ignorance and mistaken belief the debtor files for bankruptcy, Chapter 7 will exempt secured loans, which is what mortgages are, from discharge. That means that the debtor will still owe the mortgaged amounts, no relief, unless the debtor abandons the property. State laws can add to Federal bankruptcy law, but cannot supersede it, and, as we all know, state laws differ from state to state. So, a good, knowledgeable lawyer is essential. Some people “reaffirm” a mortgage loan in Chapter 7. Usually, this has no bearing. Secured loans are exempt from discharge, as stated above.
Experts and lawyers direct debtors in this situation into Chapter 13, where the court assigned trustee can negotiate and restructure the debt into something that is likely grudgingly acceptable by debtor and creditors alike. In Chapter 13, secured debt such as mortgage loans are subject to the negotiations to restructure the debt. Such negotiations will likely get the second mortgage lending company something more than what they would have gotten at a foreclosure, but maybe not as much as selling it to a collection agency. It does not matter to the debtor who is trusting to get a result that relieves the burden into something manageable.
One activity that debtors seem to not try is to personally try to reach an agreeable settlement with this second mortgage company. Nothing ventured is nothing gained, as the saying goes. Experts agree to start somewhat low, say at 10 percent of what is owed. If, and when, an agreement is reached, get it in writing. You may want to have a lawyer review the agreement before you sign. Reaching an agreement leaves all bridges intact, in the (unlikely) event that you engage this same company later on.