Subprime Lending Crisis

Man, the IRS does not miss anything.  Check this out, with foreclosures on a record pace due to the crazy subprime lending crisis, the IRS can get their grubby hands on these folks who participate in a short-sell.  A 1099-C is triggered whenever a homeowner does a short-sell.  The difference between the mortgage amount and the selling price of the house gets reported as taxable income.

Here's a scenario, say you still owe $300,000 on your mortgage but the house value has dropped to $275,000. If the bank agrees to a short sale, you'd sell the place, pay the commission and other selling costs -- let's assume $15,000 -- and turn the remaining $260,000 over to the bank. The $40,000 gap between the payment and the amount due would show up on a 1099-C form as taxable income to you.  Even the $15,000 of selling expenses gets tossed in with the amount of forgiven debt on which you owe tax.

The tax bill, however, will be forgiven if the homeowner is completely bankrupt.  But, if the homeowner has other assets, then the tax bill will take affect.