Banking: The Loan Charge Off, and the 1099-C

As foreclosures are still growing in many states, yet others have been stabilizing; it would appear that our economy has taken the turn for the better. Unfortunately, we Bankers will continue the fight over next few years to stabilize many of our credits and workout and work though many other disastrous credits…some leading to charge off’s. As Lenders we know firsthand the challenges we face working out a credits, much less the struggles we see seeking remedies. Borrowers seem to have gained many upper hands on us, but such is our world today!  

However, I’m not here to discuss workout or collections this week, but another nuance of the topic that I find of equally interesting.

 I was recently discussing openly with some colleagues how discouraging it can be to take that loss on a credit after you’ve worked so hard on. When a friend posed the question to me, what’s left to do? I of course said, file a 1099-C…and got this blank look back!  To my utter amazement, my group of Bankers and a few FDIC guys had never heard of this before.

 So today, I thought I’d pass along some information verses my usual commentary. For those of you who don’t know, the IRS rules stipulate that a Tax payer is obligated or may be obligated to report any write-off as income on their personal income tax.

So, Mr. Borrower…getting that write-off, may get you in the end anyway!

Below are some interest facts as detailed at www.irs.gov:

If an individual borrows money from a commercial lender and the lender later cancels or forgives the debt, they may be required to include the cancelled amount as income for tax purposes, depending on the circumstances. When money is borrowed and then that obligation is subsequently forgiven, the amount forgiven or received by the borrower which is affectively loan proceeds is reportable as income because the Borrower is no longer obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to the Borrower and the IRS on a Form 1099-C, Cancellation of Debt.

As with everything there are some exceptions. The most common situations when cancellation of debt income is not taxable involve:

  • Bankruptcy: Debts discharged through bankruptcy are not considered taxable income. (IRS)
  • Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets. Insolvency can be fairly complex to determine and the assistance of a tax professional is recommended if you believe you qualify for this exception. (IRS)
  • Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income. The rules applicable to farmers are complex and the assistance of a tax professional is recommended if you believe you qualify for this exception. (IRS)
  • Non-recourse loans: A non-recourse loan is a loan for which the lenders only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences, as discussed in Question 3 below. (IRS)
  • The Mortgage Forgiveness Debt Relief Act of 2007; which generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualify for this relief. This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion doesn’t apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition (IRS)

So, I suggest both the Borrower and the Lender verse themselves on the new rules and/or old rules regarding this. Also, I further suggest that you contact your Accountant for greater detail and but don’t forget about the 1099!  JR

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