What are The Tax Implications of a Short Sale? Will I Have to Pay Taxes if I Do a Short Sale?
A short sale is when a homeowner sells their home for less than the remaining amount owed on the mortgage and the lender agrees to accept the proceeds from the sale in exchange for releasing the lien on the property. The lender is then required to report the amount of the canceled debt to you and the IRS on Form 1099-C. Many homeowner’s are concerned that if they complete a short sale, they could be subject to income tax on the difference that the bank forgives between the total debt owed and the actual sale amount of the home. Many homeowners wonder if they will be obligated to pay taxes on the portion of canceled debt when they complete short sale. Will I receive a 1099-C form for my short sale? Will I have to pay taxes on the forgiven debt?
For example, if you complete a short sale by selling your property for $275,000, but you owe the lender $350,000, that leaves a deficiency of $75,000. If the lender forgives that balance and issues a 1099-C instead, then you have received a cancellation of debt in the amount of $75,000.
The Good News is That Most Short Sales Will Have No Negative Tax Implications
If you are considering a short sale and you fall into one of the below categories (which most people do) than you won’t have any tax obligations because of the short sale and you will not be taxed on the forgiven debt.
Mortgage Debt Relief Act of 2007 (Now Extended Through 2016)
Applying to your principal residence, the Mortgage Debt Relief Act excludes as income any debt discharge up to $2 million. Provisions of the Act apply to most homeowners and it includes partial debt relief gained through a Short Sale.
The Act initially covered a three-year period between 2007 and 2010, but was extended four times, to 2012, 2013, 2014 and then to 2016. This can also apply to debt that is discharged in 2017 provided that there was a written agreement entered into in 2016.
Qualified Principal Residence Indebtedness
Per the IRS Publication 4681, “Canceled Debts, Foreclosures, Repossessions, and Abandonments”, you can exclude canceled debt from your taxable income if it is qualified principal residence indebtedness. Qualified principal residence indebtedness is any mortgage you took out to buy, build, or substantially improve your main home. It also must be secured by your main home. Qualified principal residence indebtedness also includes any debt secured by your main home that you used to refinance a mortgage you took out to buy, build, or substantially improve your main home, but only up to the amount of the old mortgage principal just before the refinancing.
Canceled debt is not included in your taxable income if you were insolvent immediately before the closing of the Short Sale and cancelation of your debt. To use the insolvency exclusion, you would have to prove to the satisfaction of the IRS that your liabilities exceeded the value of your assets at that time you completed the Short Sale. Your debt includes the balance of your mortgage on the property you are short selling. Most borrowers fall into this category. In IRS Publication 4681, there is an insolvency worksheet to help you determine if you qualify for this exclusion.
If you filed for a Chapter 7 Bankruptcy before your debt was canceled through the Short Sale than you will have no tax responsibility. Filing for bankruptcy will help you avoid income tax liability for canceled debt because debt wiped out in bankruptcy is not considered taxable income. If you already filed for Bankruptcy than a Short Sale is the perfect solution for you to exit the liability of owning your home.
As with any real estate transaction it is best to enlist the services of a professional. This is especially true with a short sale. Westmarq Real Estate Group is New Jersey’s trusted short sale specialist. We help homeowners avoid foreclosure and get their homes sold quickly. Our short sale real estate team will work with your lender to negotiate a reduced payoff amount on your home mortgage so you can get out from under the debt. Contact us today and get started on the road to financial freedom.
IRS Publication 4681
Intuit Turbo Tax