The concern of some homeowners looking to do a short sale that a 1099 issued from the bank will expose them to a new problem, namely a huge income tax bill on the forgiven debt, is understandable. With home values in Westchester in 2010 at a median of $630,000, a six figure 1099 is entirely possible. In the past, a bank could issue a 1099 for forgiven debt, rendering it akin to income for tax purposes.
However, even if the bank does issue a 1099, the likelihood that you’ll have a tax problem is virtually nonexistant for owner occupants thanks to a law passed in 2007, the Mortgage Forgiveness Debt Relief Act. From the IRS website:
The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home. This is known as qualified principal residence indebtedness.
Most definitions of “principle residence” mean that you have resided there for at least 2 of the prior 5 years. That means that if you move out due to a job transfer or or other reason, you are not out of luck. Obviously, as a licensed real estate broker I do not give tax advice. You have to consult a tax professional like a CPA. However, make sure you discuss this law when you speak. It runs through 2012, and may well be extended.