When a borrower defaults on a loan secured by property such as a car loan or mortgage or willingly abandons that property rather than continuing to make payments, the lender may take the property back through repossession, foreclosure or other legal action. On Internal Revenue Service Form 1099-A, a lender notifies a borrower that it has seized the property or considers it abandoned and will retake possession. Two pieces of information on the form the principal balance and the market value helps determine whether the borrower will face any tax consequences as a result.
Boxes on the Form
Box 2 of Form 1099-A shows "Balance of Principal Outstanding." This is the amount owed on the loan at the time the lender reacquired the property or concluded that it had been abandoned. This total represents only the unpaid principal not any accrued interest, finance charges or other fees on the loan, such as late fees. Box 3 of the form shows "Fair Market Value of Property." This is what the property was worth on the date of abandonment or repossession, the date listed in Box 1. Fair market value isn't the same thing as the original sale price of the property. It's just what the lender could get for it now.
Form 1099-C
Form 1099-A simply notifies a borrower that the lender considers the property abandoned or that it has retaken possession. If the outstanding balance exceeds the fair market value of the property, the lender may try to recover the difference, or it could choose to cancel or forgive the remaining debt. If the lender cancels the debt, it sends a related form: the 1099-C, which tells exactly how much debt was forgiven. A lender that cancels debt may send both a 1099-A and a 1099-C, or just a 1099-C.
Recourse vs. Nonrecourse
An important consideration is whether the loan secured by the property was a recourse loan, meaning the borrower is personally liable for the entire balance of the loan. For example, say you took out a $20,000 car loan, then defaulted with $15,000 left to pay, and at the time of default the car had a fair market value of $12,000. If the loan was a recourse loan, the lender may not only seize the car but can also come after you for the remaining $3,000. However, if it doesn't think it can get that money or if it doesn't think it's worth the trouble, it cancels the debt. On the other hand, if it was a nonrecourse loan, the lender may repossess the car but has no legal claim on the remaining $3,000. In that case, the lender has no choice but to cancel the remaining debt.
Tax Consequences
If the loan was a recourse loan, there will be a check mark in Box 5 of forms 1099-A and 1099-C. If so, the canceled debt may be considered taxable income for the borrower. On the other hand, if it was a nonrecourse loan, then the canceled debt doesn't constitute taxable income. As far as the IRS is concerned, a nonrecourse debt is fully satisfied when the lender repossesses the property. In cases of nonrecourse debt, Box 5 won't be checked on either form.
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