Welcome to tax season!

Now is when I start getting calls from my clients asking about the tax implications of the 1099 they received from their lender from the short sale they completed last year. Luckily for me, my clients have been well prepared for the arrival of a 1099. If they got a full release of liability at the closing of the short sale, they already knew to expect it. Their questions are much more straight forward, more reminding than explaining. They want to be reminded what to do with the 1099 and what form to give to their accountant (by the way, it’s IRS Form 982) to file with their annual personal income tax. They want to know if they will have to pay tax on the amount on the 1099 (in most cases, no – see my earlier blogs here and here and video on the Mortgage Forgiveness Debt Relief Act). Fairly straightforward stuff as tax matters go for the most part.

So why the ‘Dirty Lender Tricks’?

Dirty lender tricks is admittedly a strong-ish lead in. What justifies that? What exactly am I writing about? I got a call from a client this month asking me about the 1099 that came in the mail from their former lender. My client asked me specifically about the figures on the 1099. “What does it mean that they put the full balance of the mortgage on here?” What do she mean, ‘full balance’?

Turns out, the lender had claimed that they lost the entire amount of the loan, not just the difference between what they sold the REO for and what she owed them. In fact, there was no way that all of the costs of the foreclosure plus the closing costs of the transaction could have consumed the proceeds of an REO sale. Or, if it did, that lender got taken by both their attorneys and their REO agent (highly unlikely). And of course, we had an offer on the table for about $50k more than the REO proceeds, which while it doesn’t change the lender’s actual loss, it would offset the amount of any judgment if the lender had tried to pursue it. All of that said, it doesn’t matter. The total amount of the debt was more than the property was worth, so any way you calculated it, at the net balance of equity on the property at the time of the short sale was still negative by a substantial amount – hence the short sale. Odd figures, but no big deal.

That wasn’t the Lender’s Dirty IRS Trick

That wasn’t the galling part. No, there’s another section of the 1099 where the lender reports to the IRS the value of the asset at the time of forgiveness. As I just explained above, the property was worth substantially less than the balance of the mortgage – that’s why the lender approved the short sale. And yet, on this 1099, the lender was reporting the property was worth over $100,000 more than the mortgage balance.

That bears repeating. This lender has represented to the IRS that they allowed a short sale to go through on a property they were owed $300k+ and that they took a total loss on that property, even though in the same breath and on the same document, they say the property was worth over $400k at the time.

Let me say that another way. They are telling the IRS that they allowed a short sale to go through on a property worth over $100k more than the mortgage balance, and to transact for almost $100k less than the mortgage balance.

Ok, so maybe this particular lender is either incompetent or stupid when it comes to 1099s or short sales (or both), but how does that have any impact on my client? Why is this a dirty trick?

The Lender’s Parting Shot

If you read my prior blogs on the topic (already gave you the links above – hint, hint), you know that if a property wasn’t your personal residence, then you have to qualify for the tax exemption on the forgiven debt. And that to qualify the IRS Code requires that the total value of your assets be less than the total value of your debts at the time of forgiveness.

So by inflating their stated value of the property by $100k over the mortgage balance and almost twice that amount over the actual short sale price, the lender is suggesting that the seller had substantial equity, ‘phantom’ equity really, in the property. As a practical matter, this should have no effect on my client’s eligibility, but it could trigger an audit. A nice little parting shot from your lender.

Has anyone else seen this happening or had it happen to you? I’m curious if there’s a pattern, or if this was just some disgruntled or self-righteous lender employee acting out. Leave me a comment or email me.