"He has a rental property encumbered by a 1st and a 2nd loan with Bank of America (B of A)."--->Only debt on a principal residence is eligible for the Mortgage Forgiveness Debt Relief Act of 2007.Rental property, even if it is residential property, is subject to a different set of rules. Some borrowers who own rental properties that are foreclosed or in short sales or workouts may qualify for mortgage cancellation relief under rules enacted in 1993 that apply to investment property.
"My question is whether the issuance of a 1099 means that this particular borrower will be liable for the taxes owed on the outstanding balance for the tax year in which it was issued? "--->It depends on the situation.Which 1099 Form are you talking about? 1099-A or 1099-C? Assume that you go bankrupt and your property goes into foreclosure sale and it sells for less than what you owe on the property, then there will be a deficiency.You, as a borrower, are liable to pay it off. Though your lender forgives this deficiency, it'll be considered as your taxable income. Your lender will usually send you a 1099-A Form, and you should report the income to the IRS. Similarly, if your lender modifies the terms of the loan and it results in cancellation of a certain portion of the debt, you owe the taxes on the cancelled debt amount to the IRS.
However, Your lender also should report the deficiency from the foreclosure or the short sale to the IRS for tax purposes. This is why they send you 1099-A Form, which is mainly for informational purpose.If you receive a 1099A Form, it doesn't mean the deficiency has been forgiven. This means thatthe lender can come after you in future to collect the debt.
As longa s your lender decides to forgive the debt, then he'll send you a Form 1099-C. It suggests that the remainder of the debt has been cancelled and the lender will not come after you to collect the debt. You'll be required to report this as your income on yourtax return.
Suppose the mortgage is a recourse loan, thenyou will owe taxes to the IRS on the cancelled debt amount. But the Mortgage forgiveness debt relief ac tof 2007 does allow you to exclude the cancelled debt amount from your taxable income under certain conditions,i.e., The tax relief is limited to debt amount of $2 million, or etc. If the mortgage is a non-recourse loan, the lender cannot come after you to collect the deficiency. They have to be satisfied with whatever they get from the sale of the collateral aas you can see. So, even if there's a deficiency, it will not be considered as your cancellation of debt income. Thus, you will owe no taxes to the IRS due to the deficiency on the non-recourse loan.
In the case of second mortgage, unless your second mortgage lender completely forgives your remaining debt, Mortgage forgiveness debt relief act will not come into consideration on your second mortgage debt. However, even if the fact that your second mortgage lender charges off your debt, it does not necessarily mean that your debt is completely forgiven. It just means that the second lender has sold off your debt to a collection agency who will in turn collect the payments from you at a discount value.
For further info. please visit the IRS website; The Mortgage Forgiveness Debt Relief Act and Debt Cancellation