What is insolvency?

from irs.gov site as below link states people going through foreclosure (or shortsale, both?) may not be charged with 1099c. I am not sure what insolvency means here...?

http://www.irs.gov/newsroom/article/0,,i...



2. Is Cancellation of Debt income always taxable?

Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:

Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.You are insolvent when your total debts are more than the fair market value of your total assets.Insolvency can be fairly complex to determine and the assistance of a tax professional is recommended if you believe you qualify for this exception.
Certain farm debts:If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.The rules applicable to farmers are complex and the assistance of a tax professional is recommended if you believe you qualify for this exception.
Non-recourse loans:A non-recourse loan is a loan for which the lender鈥檚 only remedy in case of default is to repossess the property being financed or used as collateral.That is, the lender cannot pursue you personally in case of default.Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.However, it may result in other tax consequences, as discussed in Question 3 below.

Insolvency is a short step away from bankruptcy. You can be insolvent without being bankrupt, but bankruptcy is a legal form of insolvency. That is why the IRS recommends the aid of a tax professional when trying to determine if you are insolvent.
The "benefit" to being insolvent vs. being bankrupt, is that it is a temporary condition- one that you are working to remedy so that you do not have to declare bankruptcy. However, this leaves you open and vulnerable to liability whereas when you declare bankruptcy, it is a legal protection from such liability.
Again, it's complicated and warrants professional help.

You may not have to worry so much. The House of representatives just passed a new bill 10/4/07 called the Mortgage Cancellation Tax Relief. Under this new bill any amount forgiven on a principal residence would not be taxed. Is not finalized yet is hopeful.