When you bail out on a Mortgage you pay tax penalties?

Question

This question actually relates to both parties in this equation.
The borrower walks, the bank writes of the loan as a loss? I imagine then the bank does this to seek some form of tax break for the loss?

The borrower is hit with a charge off or/and foreclosure, and if the bank doesnt recoup what is owed doesnt the balance get reported as a gift or at least have some tax consequences for the borrower?
I am stuck on both sides of this fence right now, I have private investors going belly up due to loans that have not been repaid, and I have borrowers thinking they can just walk because the banks arent exactly giving any sort of leiniancy for having always paid the loan on time. I feel for both sides but they both want answers and I dont have them. I am trying to urge them to go talk to tax advisors.

Answer 1

In general, for a bank to write off a loan for tax purposes, it must write off the individual loan. There must be specific proof that the loan is not collectable before this happens though.

Then, the bank will issue a 1099-C to the borrower and they borrower must report that amount as ordinary income on their taxes.

The rules could change for the borrower if they file for bankruptcy though.

Telling the borrowers to talk to their tax advisors is the best idea for you. You don't want to be the one giving tax advice in this situation.

Answer 2

If a part of the loan is wiped out, the borrower might get a 1099 for the amount at the end of the year and might have to pay income tax on it.