If you are considering a real estate short sale of your home, you should be aware that you may receive a form 1099-C for the amount of the lender's losses. This is considered loan forgiveness in the eyes of the IRS.
If you have other assets such as saving and you are not insolvent, you may end up being responsible to pay ordinary taxes on the amount of the 1099-C.
If you settle a debt with a creditor for less than the full amount owed, you may be required to report this forgiven debt as regular income, with certain important exceptions. The forgiven debts include money owed after foreclosure or property repossession or credit accounts that you don't pay. There are exceptions noted below.
If a lender forgives or writes off $600 or more of a debt's principal (the amount not including interest or fees) must send you and the IRS a Form 1099-C at the end of the year. When you file your tax return for the tax year in which your debt was written off, the IRS will require that you report the amount on the form as income.
You should attach IRS form 982 to your 1099-C when you submit your taxes.
While you may not have received this form from the creditor, the creditor may have submitted one to the IRS anyway. If you don’t list the income on your tax return and the IRS has the information of the transaction on file, you could get a tax bill or, worse, an audit notice. This could end up costing you more than just the original tax bill.
There are several exceptions stated in the Internal Revenue Code. For example, you do not have to report the income on your tax return if you discharge the debt in bankruptcy, or you were insolvent before the creditor agreed to settle or write off the debt. You should consult a qualified tax and legal counsel to see if these circumstances apply.