Canceled Debt Question
I entered into an agreement to purchase a lot in a coastal subdivision
in South Carolina. Subsequently, I was informed by an attorney in Virginia where I reside that my purchase of this property and many other people
was real estate fraud perpetrated by the seller, the developers, the appraisers, the closing attorneys, and the banks who made the loans. The FBI
investigation into this and the lawsuits surrounding this are currently ongoing and it is also in the Federal court system as well. When I
learned this, I made the decision to stop making payments including the payments to the bank, the HOA dues and the real estate taxes. I was
referred to an attorney in South Carolina to handle my case as the bank decided to foreclose. My attorney subsequently had me countersue for
fraud. Ultimately, it was settled out of court. The bank allowed me to do a deed in lieu of and my debt was forgiven. Now, I have a 1099-C for the
amount of $255,990. I do not have the money to pay taxes on this if it is ordinary income.
My question is would the infirmity exception apply here and how would I handle this on my tax return? The deed in lieu of and the 1099-C are for
the 2010 taxable year, the one I am getting ready to file. The original contract purchase price was $359,990 and the amount of the bank loan
was $323,991. All closing costs were paid by the seller who committed the fraud. The amount on the 1099-C is $255,990 and I'm not even sure
how they arrived at that figure. All payments were interest only as the terms of the loan were interest only payments for 3 years with a baloon
at the end.
The "infirmity exception" allows a taxpayer to treat debt reduction negotiated with third parties as purchase price adjustments to the extent that the debt reduction by the third-party lender is based on an infirmity that clearly relates back to the original sale (e.g., the seller's inducement of a higher purchase price by misrepresentation of material fact or fraud). I believe this falls uner 26 U.S.C. Section 108(e)(5) of IRC
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