How do you prove insolvency?
How do you prove insolvency to the IRS after a short sale?
I asked this question to multiple CPA’s and accounting firms and the general consensus seems to be the same.
After a short sale your previous lender will issue you a 1099-C , also known as a Cancellation of Debt 1099. If your short sale falls under the Mortgage Debt Relief Act of 2007 & the Economic Stabilization Act of 2008, which many primary residences do, then it’s simply a matter of notifying the IRS of that.
If it was a investment property or otherwise classified as taxable income then the 1099 needs to be offset on your taxes. If your liabilities total more than your assets then you can be considered “insolvent” and this may exempt you from paying taxes on the forgiven debt amount.
Now, the IRS is entitled to ask for documentation for all of this and if they do then as long as you can provide them with it then they should be happy.
Don’t try to do your taxes yourself during the year you do a short sale. It just isn’t worth making a huge mistake and there are many CPA’s out there who will be happy to help you and the cost really isn’t all that much. I have some good Arizona short sale resources such as accounting & CPA firms that specialize in real estate deals if you need them.