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You can run from me, but you can’t hide from them!

Let us say that I loaned you a few hundred thousand dollars so you can buy a home, even if you can’t really afford the payments. Fast forward a few years — you start fighting with your spouse because your financial problems have caught up with you, you ignore your kids because both spouses have to work, you hate your life because it is all work and no play, you ignore your faith community financially because they don’t take plastic, you try to sell expensive items but they’re not worth 30% of what you paid for them, and you don’t see an end in sight. So you do what every other good American does — you let me take “your” house back, the house that I actually own 90-100% of.

I’m your bank. I know where you live. I know where you work. I know what you buy and how much you spend every month because your credit report is available to me. You can’t run — or can you?

For many homeowners, foreclosure is happening, right now. They have no option — there’s no more money to be had. The housing bubble has deflated enough that refinancing isn’t an option because they are so upside down on their loan. Many are saddened, but the one positive in all this mess is that the bank will be the one with the bigger mess — or so the home owner thinks.

Many home owners are leaving the keys to their previous house at the bank and walking away. Being upside down is terrible, bankruptcy is bad, foreclosure is awful, but at least they’re out of that mess of a house that was so beautiful and clean and sparkling when they moved in. When they move their last possession out and lock the door for the last time, they figure it is over. The bank will sell the house at a loss and move on, right?

Wrong. The banks have a nice little weapon in their arsenal, one that many homeowners will learn about a few weeks or months after the final foreclosure occurs. That weapon? The 1099-C, or the Cancellation of Debt. If you financed your $250,000 house for $200,000 and tacked on another $150,000 in refinance cash-out when your house seemed to be worth $450,000 all-of-a-sudden, you may have walked away owning the bank $350,000 on a home that is worth only $300,000. While the house still appreciated $50,000 during the bubble growth and bust, you’re upside down $50,000 because of those wild vacations, big pools, gorgeous bathrooms, kitchen upgrades and BMWs you bought with that free money. So you figure the bank will sell the house off and eat $50,000 — which is true, except that you may end up with a 1099-C for $50,000 in the mail for this year’s tax bill. That $50,000 1099-C is an additional $50,000 in income — the bank gave you a nice $50,000 gift, and the taxman will come looking for their share.

So what happens now? Can you walk away from the taxman as easily as you walked away from the debt you signed your name on? It depends on many factors. Nonetheless, this is one area your parents should have warned you about — don’t borrow more than you can afford to pay off quickly.

Discuss this article at the housing bubble forum.