The advice I am discussing arose when a close friend called me with a real problem. In 2008, an investment property which he owned was foreclosed upon. As a result the foreclosure, the foreclosing bank received $200,000 on a property upon which my client had a $360,000 mortgage. When he did not hear from the bank in terms of a deficiency, he was understandably relieved.
Consider his chagrin when the IRS contacted him about a month ago, and informed him they were looking for a substantial sum of money (over $100,000) as a result of the fact that the foreclosure had resulted in a substantial amount of debt having been forgiven, as reported on the 1099 Form submitted by the bank for 2008. My client is a government employee who does not make a large salary. He has two small children, and his wife does not work. He called me and suggested that he consider bankruptcy.
I spoke to a bankruptcy attorney, who informed me the federal taxes are not a dischargeable debt. Bankruptcy is not a solution to this tyype of problem. I have an excellent tax accountant in whom I have great faith. When I presented the situation to him, he informed me that depending on all the circumstances, my client may be able to prove that at the time of the foreclosure, he was "insolvent" and therefore debt forgiveness in that situation is not income. We are exploring all information and hope to be able to present facts which would demonstrate insolvency. If we are successful, my client will not need to go bankrupt and thenewly asserted tax will not be payable.
Like all tax matters, the actual tax involved will be a function of all the facts and all the circumstances. This post is not meant to give anyone advice on his or her situation. All I am saying is that if you, or a client, friend or relative receives an advice of tax due based on a foreclosure, or other event which results in debt forgiveness, it may make sense to explore the person's solvency at the time of the event. In my situation, this provision of the tax code may save a person's financial life.
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