Sold real property upside down - does unpaid debt become income?

[up_side_down]

I sold some real estate in 2023 and I owed more than the proceeds, couldn't even pay all the principal let alone the interest. It was a private written mortgage and note with a relative. The documents contained a provision that I am not liable for anything more than the property value, so I am not required to pay the rest. The lender's payoff letter acknowledged this and stated he would accept the entire proceeds at closing to release the mortgage and he did not issue me a 1099-C or any kind of tax form. I think he might write it off as a bad debt on his taxes.

Should I be concerned that the unpaid shortfall might be regarded as "income" to me like some cancelled debts are? This does not seem like forgiven or cancelled debt to me since it was in the agreement from the beginning that I would not be on the hook for any shortfall. If this is considered income to me, would it be only to the shortfall of principal, or would it include the shortfall of interest as well?

Thanks

[Carl]

Sounds like short sale to me. I assume your lender approved this. If you are required to pay any taxes on the unpaid amount of your loan, the lender will send you a 1099-C. Until then, you have nothing to report. If/when you get a 1099-C, pay attention to what tax year that form is for. Otherwise, if no 1099-C is issued to you, you have nothing to report. Overall, I would expect a 1099-C. Assuming you closed on the short sale in 2024, you may receive a 1099-C next year, for the 2024 tax year.

[up_side_down]

It was in 2023 and the lender did not do a 1099-C. The lender approved it by writting the payoff letter acknowledging the situation and stating he would accept the proceeds of closing. If the lender is not a business or bank, but just works for an unrelated nonfinancial industry employer, is not routinely in the business of lending money to people, but writes it off as a non business bad debt on his personal tax return, must he do a 1099-C? How do these facts affect my situation?

[Carl]

The lender's facts should not/do not matter to you. If the lender does not issue you a 1099-C, then you have nothing to report. It doesn't matter if the lender was a banking institution or a family member.

[Anonymous_]

@up_side_down:

It's nonrecourse debt. Follow the IRS guidelines (below).

[so, basically, you sold the property for the balance of the loan]