How do I reduce the amount of taxes owed after a foreclosure?

After losing my job, I lost my rental property to foreclosre. The defaulted loan was for $88,000 and the house and land were originally appraised for $95,000. However, when the lender issued my 1099, they used the county's tax assement of $45,000 as the value of the property. Because the 1099 represents a forgiven debt, the IRS sees this as a capitol gain of $43,000. I obviouslly couldn't afford the property, so I how do I convey that I can't afford the $5,600 I now owe the IRS?

A foreclosure on a home may also result in a 1099-C from the mortgage lender if the property is sold for less than the amount of the loan. In this instance, a person loses their home and may also face a tax bill. Usually, the bill comes many months after the tax return was filed as a result of an IRS document matching program. This "under-reporter" notice brings grief to the taxpayer.

The key issue is whether or not the debtor was insolvent. If they were insolvent, it may not be taxable depending on the circumstances. There is an "Insolvency exclusion." You are insolvent when, and to the extent, your liabilities exceed the fair market value of your assets. So it is possible none of your forgiven debt is taxable or it is possible that all or only a portion of it is counted as income.

You may not have any taxable income from the 1099C, but you must account for it on your return. The issue is whether or not you were solvent at the time of the debt cancellation. You only owe tax on the forgiven debt to the extent you were solvent. For instance, if the forgiven debt was $10,000 but you are only worth $5,000; you would only be liable for income tax on that amount. A home foreclosure is complicated and you may have other legal arguments besides insolvency.

There are five situations where a cancelled debt does not have to be reported as income:
Bankruptcy 鈥?the debt was already discharged through a bankruptcy proceeding.
Insolvency 鈥?your total debts exceed your total assets at the time your debt was settled or deemed non-collectable.
Indebtedness is due to a qualified farm expense.
Indebtedness is due to certain real property business losses.
Discharge of your debt was treated as a gift (You owed Mom $10K and she said "Don't worry honey, consider it a gift").

If you are insolvent you need to explain this to the IRS on your tax return. You can fill out IRS Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness or attach a detailed letter to your tax return explaining the calculation of your total debts and assets.

Your capital gain or loss starts at the purchase price .If your purchase price is not used by the IRS then go and see them.