Just thinking loud...

Ok, here is the situation.
Mr. Homeowner owns a house and owes almost as much as it’s worth. For some reason he is falling behind with his payments and starting to look around for the options. Here comes Mr. SS Expert who is willing to negotiate with the bank and purchase the house from Mr. Homeowner. Say the house’s worth 200k, and Mr. SS Expert buys it for 135k after negotiating with the bank. The house is flipped to another investor, and Mr. Homeowner can finally breath freely. BUT next year the bank sends him a 1099 that reflects the amount of 65k that is taxable for Mr. Homeowner. Obviously, bank lost money, so the least they can do is to write-off their loss and pass it on to Mr. Homeowner. Now Mr. Homeowner is even in the bigger hole than he was before. Now he has to pay taxes from 65k (16,250 if he is in 25% bracket).
So tell me, HOW is negotiating the SS with the bank helping homeowners in distress? :o

thank you RDR for providing this link in another topic:
"You are considered insolvent if your liabilites (debts) exceed your assets (what you own).

Your gain or loss on the sale is determined by subtracting your cost from the proceeds of the sale (what the house sold for minus expenses of the sale. This NOT the cash you received). If a gain, it is not taxable if you lived in the house for 24 of the past 60 months as your main home. If a loss, it is not deductible.

If the sale was sufficient to cover the mortgage there is no tax issue. If the sale did not cover your debt, and the mortgage company cancelled the debt, you have income in the amount of cancelled debt UNLESS you were insolvent at the time. In this, the cancelled debt is not taxable to the extent of your insolvency. In other words, if your liabilities exceeded your assets by $25,000 and the amount of forgiven debt was $30,000, you would have $5,000 in taxable income.

Hope this helps. I apoligze for such a long, technical answer, but without all the details I had to try and cover all the possibilities.

John Stancil, CPA"
borrowed from experts.about.com/q/Tax-Law-Questions-932/Short-Sale-Home.htm

No problem, here is another post on that topic at the same website, different accountant. Also refers to the form used to reduce 1099 amt.

http://experts.about.com/q/Tax-Law-Questions-932/short-sale-cancelled-debt.htm

And if the property goes to auction. THe HO could be 1099’d for the whole kit and kaboodle, its the lesser of two evils to do the ss. But then again, the bank will probably realise that if the HO cannot pay the mortgage, what are the chances they are going to the difference. hmmm…
steve