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Discussion:CA State Foreclosure and Form 1099-A

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Discussion Forum Index --> Advanced Tax Questions --> CA State Foreclosure and Form 1099-A


Discussion Forum Index --> Tax Questions --> CA State Foreclosure and Form 1099-A

Sfbcpa (talk|edits) said:

28 January 2011
I know there have been alot of discussions about Forms 1099-A and 1099-C which I have read, but I wanted to start a new thread discussing Box 5 of Forms 1099-A.

Can anyone tell me why the banks are checking box 5 as Yes on the Forms 1099-A when the properties have been foreclosed on and the banks are not going to come after the debtors for the balance on the note? For example, one of my clients has a rental property that was foreclosed and sold at auction in 2010. The FMV is $50K less than the balance on the note. The taxpayer called the bank asking if he is still liable for the $50K and the bank pretty much said NO. They said that they marked box 5 Yes because he is liable for the tax on the debt. But that is not what box 5 is asking. Box 5 is asking if this debtor is personally liable or not...recourse vs. nonrecourse. This confuses the tax reporting because it seems as if the bank is still holding him liable and could issue a Form 1099-C in the future.

Since this is a CA foreclosure I assume that the balance of the note is deemed to be canceled in 2010 when foreclosed and sold at auction. But what happens if in a later year the bank issues a Form 1099-C? If I have already reported the income from the canceled debt in 2010 won't this create problems with the IRS?

CATaxAtty (talk|edits) said:

28 January 2011
I don't know if David Fogel has gotten tired of responding to these questions (I wouldn't blame him). But if you get a chance, I would take a look at his very good set of publications - www.fogelcpa.com - addressing these issues. The short answer here is that Box 5 is often checked incorrectly and the client would do well to double check whether he/she is in fact, on the hook for the loan.
   This investigation begins with an inspection of the loan documents to see whether the loan was recourse or non-recourse (recourse = secured by the borrower / nonrecourse = secured only by the property).  If the loan documents say it is a recourse loan, then the next step would be to look at CA CCP section 580b (the anti-deficiency statute), which may apply if the client ever occupied the property.  If not, then finally, some (I should say 'I') have raised the question (an open question at that) of whether the foreclosure itself has any effect on the recourse / non-recourse nature of a loan in light of CA CCP section 580d (the one-action rule), which says basically 'you're done' once the lender seizes the property in a foreclosure.  
   If you've gotten this far and the client is still on the hook for the loan, and is issued a 1099-C, then most likely he/she would want to look to the exclusions under IRC section 108 - namely the exclusion for real property business indebtedness (assuming this was an active rental).
   Good luck!

KatieJ (talk|edits) said:

28 January 2011
Nonrecourse mortgages under California law are either purchase money mortgages for the purchase of owner-occupied residential property (up to 4 units as long as the debtor occupies one of the units), or a contract for deed (where the seller carries the debt) for such property. CA Code of Civil Procedure Sec. 580b, as cited by CATaxAtty. A loan that financed the purchase of residential rental property, never occupied by the borrower, is recourse debt under California law unless the debt instrument specifies to the contrary. Sfb's client's 1099-A probably was correctly completed by the lender, because the debt in question is recourse debt.

DaveFogel (talk|edits) said:

28 January 2011
"The taxpayer called the bank asking if he is still liable for the $50K and the bank pretty much said NO."

Under section 580d of the California Code of Civil Procedure, which, as CATaxAtty points out, is commonly referred to as California's "one-action rule," if a lender uses the non-judicial foreclosure process (notice of default, period of redemption, property sold at trustee's sale), as opposed to the judicial foreclosure process (a lawsuit filed against the borrower to obtain a deficiency judgment), then the lender is prohibited from later seeking to obtain a deficiency judgment against the borrower. In other words, the balance of the debt is canceled by operation of California law. This may explain why the bank said that the client is not liable for the $50K balance owed on the note.

Many lenders do not believe that they have to issue a Form 1099-C in this situation because THEY are not canceling the debt, but rather, it's state law that's doing it. So, they issue a Form 1099-A instead.

I agree with KatieJ that a loan that financed the purchase of residential rental property that was never occupied by the borrower is recourse.

Sfbcpa (talk|edits) said:

31 January 2011
Thank you all. I completely understand it now.

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