IRS tax liability on short sale or foreclosure in 2013, post-BK?

[btbeme]

For clarity's sake, lets get this out on the table. Say a couple has their Ch 7 BK discharged in 2012, including their upside-down mortgage liability. Now, it is pretty much a fact that the BANK cannot sue, etc for the deficiency if the couple does a short sale or foreclosure in 2013 (barring fraud, of course) since their Ch 7 discharge erased that possibility.

The bigger question is whether their possible IRS tax liability is also washed away. Since the Debt Forgiveness Act expires on Dec 31 2012, it seems that a foreclosure or short sale after the first of the year would expose that couple to the possibility of receiving a 1099 for the deficiency - one that the IRS can absolutely pursue. It seems that the only way to avoid that heavy tax bill would be to be able to claim insolvency for the purpose of discharging that tax liability on Form 982.

So...regardless of their Ch 7 discharge, does a person have an IRS tax liability if they foreclose or short sale in 2013? If so, shouldn't the insolvency worksheet make that go away? Any other recourse if the insolvency numbers do NOT fall in the couple's favor?

[keepsmiling]

If you have filed bk, and didn't reaffirm, there should be no tax liability. Period. Ever. The bk makes it the debt fail to be one, so there can be no "forgiveness".
If you haven't filed, then after this year you could owe - unless they extend the exemption.
At least that is my understanding.

[LadyInTheRed]

keepsmiling's understanding is the same as mine. Even before the Debt Forgiveness Act, you did not pay tax on debt discharged in BK. Yes, you have to file form 982 if the bank sends you a 1099. But, you simply check the box that says the debt was discharged in BK. The Debt Forgiveness Act helps those who did not file BK.

[HHM]

1. You most likely WILL receive a 1099-C
2. As stated above, if you filed BK, received your discharge, and did not reaffirm, then NO tax liability.
3. However, the IRS does not know you filed BK. So if (when) you receive a 1099-C, you will need to complete IRS form 982.

Note, the 1099 is merely a reporting document, it merely reports an "event".

[btbeme]

OK, then a different scenario...

Couple has a foreclosure in January, after the Debt Forgiveness Act expires. House was $150k upside down, which will result in a large 1099 from the bank. Will their March filing of a Ch 7 take care of that bill? Or is the strategy to file BEFORE the foreclosure (or short sale)? Or does it matter?

[keepsmiling]

Shouldn't be an issue.
I expect that if the Act is not extended, we will see a sharp increase in filings. It's going to force a lot of folks who otherwise wouldn't have to.

[HHM]

OK, then a different scenario...

Couple has a foreclosure in January, after the Debt Forgiveness Act expires. House was $150k upside down, which will result in a large 1099 from the bank. Will their March filing of a Ch 7 take care of that bill? Or is the strategy to file BEFORE the foreclosure (or short sale)? Or does it matter?

I have addressed this in a few posts. Commentators differ on the issue.

-The 100% certain, guaranteed strategy to avoid the tax debt, file BK BEFORE the foreclosure. Then there is no question.
-I believe you can file BK after foreclosure, but within the same tax year, and still avoid the tax (in this scenario, I recommend still filing form 982 and marking the BK exception, then let the IRS tell you you were wrong and fight it at that point. To my knowledge, I haven't seen a case on the subject).
-If you file significantly after foreclosure, e.g. not in the same tax year, then I think all bets are off; the BK won't be the basis for avoiding the forgiven debt tax.

Note, most people will probably qualify for the insolvency exception.