A bankruptcy court in Pennsylvania recently ruled on an issue that has been a frequent source of confusion to those working with short sales.
The issue is whether a 1099-C issued by a lender to a borrower automatically relieves the borrower of liability for the debt. In other words, is a creditor prevented from pursuing collection of a debt for which it has issued a 1099-C pursuant to IRS requirements?
A 1099-C is issued to the borrower by the lender for “cancelled” debt. This debt generally is taxable income to the borrower. The exceptions to this have been covered extensively in other articles including that for purchase money debt on a primary residence.
In the case of In re Zilka (407 B.R. 684) the court considered this issue in a situation that did not involve a short sale. Nonetheless, the case is illustrative of what may happen when a court considers the issue in a short sale context. The judge wrote:
[The creditor’s] issuance of the Forms 1099-C did not itself operate to legally discharge the Debtor from further liability on each of the [creditor’s] four claims. That is because Forms 1009-C, as a matter of law, do not themselves operate to legally discharge debtors from liability on those claims that are described in the Forms 1099-C.
The court addressed the issue of a taxpayer who has paid tax on cancelled debt that is the subject of the 1099-C. It found that the issuance of a corrected 1099-C would allow the creditor to pursue the debt in such a situation. This can be distinguished form a short sale of a primary residence where the owner most likely is subject to tax relief.
Robert B. Noggle, Esq.