1099-Imputed Income

What is the name of your state? AZ

I know that when lenders accept money as a settlement to release a person of the obligations of a mortgage/d/t and promissory note, the lender provides that person with a 1099 because the defeciency is imputed income. (so say you short sale your house and you owe $200k, the buyer offers $150k and the bank accepts - the bank gives you a 1099 for the $50k defeciency).

I also know that if the house is bought as an investment house, the 1099 can be offset because you can claim a loss on the property. I also the know the offset is not dollar for dollar.

However, I was recently told that the loss will likely be a capital loss and only offsettable to a certain extent against ordinary income. It will be offsettable against other capital gains if he has any and there may be some carryforward and carryback associated.

can anyone help explain what this means as I don't know much about tax law.

Income is divided into 2 categories when figuring your tax: ordinary income & capital gains. Long term capital gains (& qualified dividends) get taxed at special, lower rates (usually 5% or 15%). Ordinary income is taxed at graduated rates (10, 15, 25, 28, 33, 35%). Since capital gains get favored treatment when figuring taxes, capital losses get disfavored treatment. A net capital loss can only offset $3,000 of ordinary income. Net capital loss means that your overall losses exceed your overall gains.

Many 1099-C's do not actually produce taxable income, since the taxpayer can file a form showing that he was insolvent when the debt was released & exclude the debt relief from income.

What form is used to show that the taxpayer is insolvent for that 1099-C?

Ok, so my buddy is a loan officer. Since the market went into a slump he has made zilch (literally).