Do I Owe Taxes From a Form 1099-A?
When you are given a loan, the Internal Revenue Service does not consider the loan amount income because you are obligated to pay back the loan. If you are unable to pay back a loan and the lender completely forgives the debt, you are required to pay income tax on the full debt amount. If the forgiven debt was on property, you will receive a Form 1099-A in the mail. You must report and pay taxes on the full 1099-A amount unless you meet a few specific exceptions.
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Taxable Income
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The IRS uses a broad definition for income. Income is usually associated with money coming in from wages and investment earnings. Transactions can be considered taxable income even if they do not give you a cash return. This is known as phantom income. The IRS will consider a gain taxable income if it improves your net worth even if you do not receive any cash. This can create liquidity problems for paying taxes.
Income from Forgiven Debt
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When a debt is forgiven, the total amount of the debt must be reported as income by the person who no longer has to pay the debt. The debtor's total net worth increases as they no longer have to pay a debt liability, so the IRS considers this transaction as taxable. The lender is allowed to deduct the forgiven debt from his income tax. Because the forgiveness of debt creates a taxable event without returning any cash, it is an example of phantom income.
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Filing
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When you have a debt forgiven for a piece of property, you will receive a Form 1099-A for the amount of debt. You receive a Form 1099-C for the forgiveness of unsecured debt. Receiving a Form 1099-A is like receiving a W-2 tax form. You must add the total amount of income on the Form 1099-A to your gross taxable income for the year. The net result of the 1099-A will be to increase your income taxes for that year.
Exceptions
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There are a few exceptions when a 1099-A transaction will not result in taxation. You do not have to report a forgiven debt for the discharge of the mortgage on your primary residence. You do pay income tax on forgiven debt if you declare bankruptcy or you become insolvent. Finally, you do not need to pay taxes on your forgiven debt if the loan on your property was a non-recourse loan. In this case, the lender can only repossess your property and is unable to report the forgiven loan as an income deduction.
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References
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