Pre-Foreclosure Workouts, Loan Modification Agreements and 1099-C Tax Consequences of Debt Forgiveness

Posted & filed under Foreclosure Defense.

In this recent era of mortgage lenders being increasingly open to pre-foreclosure workouts and loan modification agreements, it is imperative that property homeowners understand the potential for taxable income consequences that could arise as a result of the loan modification agreement.  In the past when a homeowner was behind on their mortgage, the primary solution to remain in the home was a Bankruptcy Chapter 13 reorganization plan.  Now there is a push from the federal government to induce mortgage lenders to participate in federally created programs to help property owners stay out of foreclosure and keep their property.  Some of these federal government foreclosure avoidance programs include, the Making Home Affordable Modification program (HAMP), the National Mortgage Settlement, and Home Affordable Refinance Program (HARP), all of which encourage the rewriting of loan terms.  For mortgages that are not eligible for loan modification agreements within federally mandated programs, workouts could also occur outside of these programs with private investor loan modification agreements and pre-foreclosure workouts.  No one set of rules applies to modifications and workouts for all mortgages and the type of workout that is available for a particular type of mortgage may change over time.   

Obtaining a loan modification agreement or other workout can be a complex process with confusing guidelines.  A key factor to remember is that if you owe a debt to a lender and that lender cancels or forgives a portion of that debt in a pre-foreclosure workout or loan modification agreement, there is a substantial possibility that unless you fit into a certain federal exclusion, this canceled or forgiven debt amount will be considered income to you for income tax purposes.   

I know this is a somewhat confusing concept; consequently, I will try to make it easier for you to understand.  Look at it this way, when you initially borrowed the money from the lender for the loan, you did not have to include the loan amount as income for tax purposes, because you had an obligation to repay the loan to the lender.  However, after a loan modification workout is implemented and all or at least $600.00 of the loan obligation is forgiven, then the forgiven amount is generally reported as income to the IRS because you no longer have an obligation to repay the lender, unless your situation fits into an exclusion.   The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.  However, there are exceptions to this income reporting requirement, so to determine whether you fit within one of these exceptions, consult a tax attorney or CPA.   

I AM NOT A TAX ATTORNEY.  ALWAYS CONSULT A TAX ATTORNEY AND OR CPA when assessing potential tax consequences in a short sale, foreclosure, forgiveness of debt, or loan modification agreement.  Another helpful resource is to consult the IRS website,, and retrieve IRS Publication 4681, which is entitled “Canceled Debts, Foreclosures, Repossessions, and Abandonments”.