If you need to walk away from real estate, a boat, a car, or other expensive personal property, it is a good idea to speak with a bankruptcy attorney. The federal bankruptcy laws may allow you to walk away from the debt without owing additional money on the property.
Surrendering property before bankruptcy can create a new debt, called a deficiency balance. Essentially, a deficiency balance is the amount owed on a loan after the property is sold. Returned property is often sold at auction, which commonly brings less than the property’s real value, so you are left owing the remaining balance.
In many cases a deficiency balance can be avoided by surrendering the property during bankruptcy. Most courts will allow you to surrender certain property back to your creditor in full satisfaction of the outstanding debt. That means that the creditor takes the property back, but has no further claim against you. This has little value during a Chapter 7 bankruptcy, but can mean a great deal you file a Chapter 13. By waiting to surrender the property during the Chapter 13 case, the creditor has no unsecured claim to add to your monthly plan payment.
Surrendering property in full satisfaction of a debt is a complicated bankruptcy issue and there is disagreement among the circuit courts as to its applicability. If you are considering walking away from property, speak with a knowledgeable bankruptcy attorney in your area to discuss your options.
When a creditor “forgives” a debt, the creditor is required to issue an IRS Cancellation of Debt Form 1099-C. This form is sent to the IRS and to the debtor. The IRS includes the amount of the cancelled or forgiven debt as income, unless the debt is protected by the Mortgage Debt Relief Act of 2007, the debtor is insolvent at the time of the cancellation, or some other exception applies. If the debt is not excepted, the tax debt owed to the IRS can be very difficult, if not impossible, to discharge. While the Tax Code provides several exceptions to a tax levied by a cancelled or forgiven debt, it is never good to be on the radar screen at the IRS.
A debt that is surrendered during bankruptcy is not taxed as income. The federal law specifically excludes all debts discharged during bankruptcy from income. As a result, it is always better to file bankruptcy before a creditor forgives or cancels a debt and issues a 1099-C.