A recent federal bankruptcy court ruling in Tennessee may someday provide relief to people who are being targeted by their former lenders to pay the balance on their mortgages long after they lost their homes in foreclosure.
Last Sunday, The Post reported that many people in the Washington area, including 400 in Maryland, were being sued by their former lenders to pay the “deficiency” on their mortgages — the balance on the loan that was not paid after the bank sold the house after a foreclosure. The people were taken by surprise because they had assumed that their obligation to the lender ended when they surrendered the property.
The District and some 40 states, including Maryland and Virginia, allow lenders to go after consumers for the deficiency. An attorney in California wrote me that in his state “lenders are selling those debts to collection agencies and they are actively trying to get payments.”
But the bankruptcy court ruling in Tennessee ultimately may provide a way out for former homeowners who received IRS Form 1099-C, a cancellation of debt document. Typically, the lender sends you the IRS form, telling you that your debt has been canceled. That form is used to calculate whether you’d owe any federal taxes (which Congress suspended this year) or state taxes on the amount that was forgiven.
The federal bankruptcy court held that while the form itself does not cancel the debt, the fact that the financial institution has issued that form “reflects” that it has actually discharged the indebtedness. The court relied on many cases which state that “cancellation of debt (COD) is a term that is interchangeable with the term discharge of indebtedness.”
And the judge made it clear that since canceled debt is generally considered as income for the debtor, it would be unfair for the taxpayer to be hit both ways: paying the tax and paying the lender. That the former homeowner may not be legally obligated to pay income tax on the amount did not change the judge’s view.
The bankruptcy judge acknowledged that “it has adopted the minority view; however, in the interests of justice and equity, the court believes that this is the proper view.”
In fact, the judge was rather critical of lenders, claiming that they “play both sides with respect to the filing of a Form 1099-C.” In some cases, the judge said, the bank argues that the form “is filed merely to comply with the Internal Revenue Service’s reporting requirements.” However, when required to defend against allegations that it violated the Fair Debt Collection Practices Act, another bank told the court that “the issuance of an IRS Form 1099-C is not an attempt to collect a debt; instead, it is a declaration under penalty of perjury that the debt has been canceled” and that the bank “would never attempt to collect the debt.”
That case is law only in Tennessee, Kentucky, Ohio and Michigan. There are other cases holding the opposite view that the form is not an admission that the loan has been discharged. Because there are opposing decisions on this important issue, it ultimately will be decided by the U.S. Supreme Court.
If you received the form 1099-C and the lender is pursuing you for a deficiency, contact an attorney in your jurisdiction and tell him or her about the William Reed case (Eastern District of Tennessee bankruptcy court, case No. 12-30049, decided May 14.)
The lender must file suit against you to collect. You have the absolute right to file a defense, claiming that the 1099-C form you received from the lender is clear evidence that your debt was canceled. Doesn’t “canceled” mean anything?
For more information, attorney Julian Block has a very helpful book, “The Home Seller’s Guide to Tax Savings,” which can be purchased at www.julianblocktaxexpert.com . Additionally, the IRS has a publication (#4681) titled “Canceled Debts, Foreclosures, Repossessions and Abandonments.” It’s a complex area of law. According to Block, “Publication 4681 is tough reading even for me and other tax mavens, who put food on our tables by interpreting arcane provisions of the Internal Revenue Code, and it would’ve made James Joyce envious.”
You should also write to your state representatives and demand that they join the other states and enact legislation prohibiting lenders from seeking deficiency judgments.
Benny L. Kass is a Washington lawyer. This column is not legal advice and should not be acted upon without obtaining legal counsel.
For a free copy of the booklet “A Guide to Settlement on Your New Home,” send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036.