Are there Short Sale Tax Implications?
The answer to this question is "sometimes". Both Federal and State (California) laws that have been enacted that exclude most owner occupants from paying tax on the debt forgiven through a short sale. However, these exclusions do not apply under certain circumstances.
The Mortgage Debt Relief Act of 2007
The answer to this question is "sometimes". Both Federal and State (California) laws that have been enacted that exclude most owner occupants from paying tax on the debt forgiven through a short sale. However, these exclusions do not apply under certain circumstances.
The Mortgage Debt Relief Act of 2007
From the IRS website, www.IRS.gov :
If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.
The most common situations when cancellation of debt income is not taxable involve:
· Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
· 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.
· Certain farm debts
· Non-recourse loans: A non-recourse loan is a loan for which the lender’s 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.
California Mortgage Relief, SB 401
A new state law allows taxpayers to immediately exclude from their income the amount of mortgage debt on their home loan that has been forgiven by their lender. The law largely brings California statutes into conformity with current federal law. The law largely brings California into conformity with the federal Mortgage Forgiveness Debt Relief Act for discharges that occurred in tax years 2007 through 2012. However, California’s limits of qualifying principal residence indebtedness differ from federal limits. ($500k, $250k for married filing separately). It applies to debt forgiveness in 2009 through 2012 resulting from a foreclosure, "short sale," or loan modification of a taxpayer’s qualified personal residence.
What if I Don't Qualify for a Tax Exemption on the
Debt Forgiveness?
Debt Forgiveness?
For situations in which you are unable to claim a tax exemption on cancellation of debt, a short sale is typically far preferable to a foreclosure, as the lender will lose more money on a foreclosure creating a higher amount of debt-forgiveness which will increase the potential tax consequence. Always consult your CPA for specific tax advice to your situation.
Please email or call us at 714-989-6176 for a no-cost, no-obligation, confidential foreclosure prevention consultation.
Please do not consider this legal advice. Advice in specific situations may differ depending upon a wide variety of factors. Please consult an attorney & CPA.
