Could someone enlighten me on the tax implications for the homeowner of a short sale. My understanding is that if they had refinanced there would be a 1099 issued, but if it was the primary purchase loan there would be no such issuance. Could someone please elaborate or clarify if I am not correct.
My understanding is that with any forgiven debt on a mortgage the seller should expect a 1099 from the lender.
There is currently an effort to stop the issuance of 1099 for forgiven debt in hardship cases in congress but who knows where that will go it requires a change to the tax codes.
If there is a forgiveness of debt, then the lender should issue a 1099-C. If you originally financed the property with 10% down, chances are that you would still have basis more than the amount owed. It would be considered a sale and the selling price would be the debt discharged (amount on the 1099-C) and the basis would be (purchase+improvements-depreciation). You would have to go through the numbers, but you have to recognize this as a sale and use the 1099-C as your proceeds and show your gain or loss on your schedule D.
If this is a personal residence, then they may not issue one, but if they do, then you simply have the proceeds shown and the purchase price + whatever improvements you made and show a disallowed loss on the return.
You owe the tax even if the 1099 is not issues by the lender. Failure to report and pay is your problem.
The IRS does allow some debt to be forgiven without taxes being owed. There is a page on the IRS website that goes into the details. It was months since I read it so I do not have the specific link to the page.