As if things weren’t hard enough for investors who got in during the real estate boom and then fell during the bust, now we have to worry about another IRS audit target specifically at those who lost.
Rumor has it (I’ve yet to see anything authoritative from the IRS about this) that the IRS auditors are taking the position that Form 1099-As are all they need in some cases to assess cancellation of debt income.
Please look at the last blog article I posted “IRS Quietly Issues New Instructions for Reporting When You Dump Bad Real Estate” for a quick synopsis of how it is supposed to work.
The problem is that the lenders aren’t issuing Form 1099-Cs like they are supposed. I’m not sure that’s why the IRS is now relying on Form 1099-As to report COD income, but I suspect it is.
If you receive a Form 1099-A that shows the loan is non-recourse to you, or if the property is in a state that is non-recourse then you will likely have Cancellation of Debt income. The problem is that in most cases the values given on the Form 1099-A are ridiculous. We tend to see amounts that are hundreds of thousands of dollars more than fair market value or $0. It’s all or nothing and neither is right.
In reality, fair market value is determined by what a willing buyer and a willing seller determine it to be. So a lender’s guess isn’t necessarily going to be accurate anyway.
And finally, the question of recourse or non-recourse isn’t a simple yes-no. In most states it depends on the type of mortgage and the type of foreclosure. A lawyer needs to make that determination. For the person who has just had their real estate portfolio decimated and likely exhausted personal resources just trying to stay afloat, getting the advice of a lawyer and a CPA with experience in real estate matters and particularly this issue, may be too much.
Those are all the reasons why I don’t like the position that the IRS is taking on some audits. I suspect they are taking this position just to see what happens. If they get challenged and lose in Tax Court, they’ll roll back. Meanwhile, if you’re one of those people who got Form 1099-As and never got a Form 1099-C, you may be soon getting an audit notice.