Did you or someone you know just receive a 1099-C form from their previous mortgage company after a short sale? If you owed more on your house than what you sold it for through a short sale, the excess amount of the loan balance above the sales price may be forgiven by the lender. The forgiven amount is considered cancellation of debt (COD) income for federal income tax purposes. As an example: Your current mortgage balance is $200k. You execute a short sale and sell the house for $150k. You still owe the bank $50k. This $50k may be forgiven by your lender. If it is forgiven, the forgiven amount is considered income for your tax filing purposes. But there is some good news.
The Mortgage Debt Relief Act of 2007 allows taxpayers to exclude the income from the discharge of debt as long as the property sold in the short sale was their primary residence. The act applies to debt forgiven in calendar years 2007 through end of 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). For additional info, please visit the IRS website: Ten facts for Mortgage Debt Forgiveness.
You still have to report the forgiven debt as income on your personal tax return but you must file IRS form 982 to exclude this as part of your income. As always, consult a certified tax professional to seek advise for your particular situation.