I have written about the Bankruptcy Appellate Panel Decision in the matter of In re Veal. I have mentioned that two prominent tax attorneys reviewed it with me…we have made a VERY interesting and compelling argument. In a situation in which the borrower has an approved short sale, and receives a 1099 or 1098 from the lender that indicates a “forgiveness of debt issue”, there is a way to negate the tax ramifications (in addition to the provisions of the Internal Revenue Code (IRC) and the Mortgage Forgiveness Debt Relief Act (MDFRA).
Suppose the a borrower owed $1 million on a property and there was an approved short sale for $600,000 and the bank issues a 1098 for $400,000 (I might mention that regardless of whether the bank issues a 1098, the money/tax is owed). Further assume that the MFDRA and IRC guidelines to not apply and it appears that the borrower owes taxes on the forgiveness.
WELL…here is a scenic argument….if the lender does not have proof that it has the original note and that it has standing to even sue, they cannot properly issue a 1098 either and it can be voided!!! This will apply to all borrowers regardless of whether they are in bankruptcy. Apparently, former IRS auditors agree with this!!! If the bank cannot prove that it holds the original note, the obligation is invalidated not forgiven!! This is potentially HUGE!!! In other words, the debt is not forgiven, it never legally existed!!
However, I would not counsel my clients on this and neither should 99% of us on AR…it is a tax issue and should be handled by appropriate tax attorneys. HOWEVER, I can tell you that this logic/theory has already helped get a short sale under contract in California because the seller was concerned about the issue, but he has heard enough from me that he is willing to go through with the sale and consult with my colleagues on the forgiveness issue. Apparently, his CPA called the tactic “novel” and stated that it should work!!
The reason that you will need a tax attorney and not a CPA to make this argument is that it is a legal argument initially (that the lender does not have standing, etc). If you would like a referral to outstanding tax attorneys on this and other issues…send me an email and I will provide the info. I did not want the blog to become an advertisement for others’ services.