Foreclosure/deed in lieu question

[Margaret CPA in OH]

A client just called with the following question:

"I'm behind 4 months on my FHA loan and the lender denied a short sale because the property has had tenants there for the last 18 months. I tried getting a reduced interest rate but re-writing a loan with 20yrs left to a new one with a lower interest rate for 30 yrs ( the only term they would offer me) made me pay more. They denied refinancing the loan because I owe more than it is worth with the down economy.

Question #1 If I let the home go into foreclosure, can the lender/investor come after me with a 1099 for the difference being that it is a FHA Loan?

Question #2 If I do a deed in lieu of foreclosure, can the lender/investor come after me with a 1099 for the difference being that it is a FHA Loan?"

This relates to one of their rental properties in the inner city. It has put a severe drain on their finances and relationship. There used to be good tenants but he said the current ones are destroying the property and he can't afford the legal expense to remove them. He thought he was doing the right thing by keeping it occupied but now is penalized for that. He kept up the payments until Wells Fargo said they wouldn't do anything unless he was behind in payments so he stopped payments.

Any ideas or suggestions? He is my first client dealing with any of this stuff and it is a rental, not their personal residence.

Thanks in advance!

[Jack from Ohio]

Yes and Yes. Also, the 1099 is the least of his worries. If a short sale or foreclosure, he must count the amount "forgiven" as the sale price of the property. He may have capital gains, despited the short sale or foreclosure. I will find the link to the IRS section that tells this. I will post it later.

Either way, he will get a 1099C and/or a 1099A since it is a rental property.

[Margaret CPA in OH]

Thanks so much for this, Jack. I suspected this was the case and warned him as I've read so many posts this past season from others. But before giving these unfortunate answers, thought I would just double check with this amazing resource. As I recall from earlier posts, there may be a timing difference which could help him get together some resources I feel badly for him as he was trying to do the good thing by providing low income housing in a tough neighborhood. Too bad the original good tenants left over the years.

[Pacun]

When the sale or dispossition happens, you don't know if the bank forgave any debt. So, you deal with the facts on the papers and report the sale on your taxes. If the bank ever forgives you the debt, then you will get a 1099-C and you will have to deal with it at the point.

I doubt the bank will forgive the debt that easy since it seems this person has at least one more real estate property.

[Margaret CPA in OH]

Thanks, Pacun, for the follow up. I seem to recall that you were quite involved in the earlier threads about this and what you stated rings a bell. I think it is so short sighted of the bank to not work with this guy, though. They will end up with a poor property that will only decline further without active management.