Short Sales, Mortgage Forgiveness, and Tax Consequences Posted on February 2, 2013 by John Clabaugh In a short sale, the proceeds from the sale of a home are not enough to pay off the outstanding mortgage. In other words, the seller and the seller’s lender agree to sell the home for less than the amount of the mortgage. Learn about short sales. The difference between the proceeds from the sale of the home and the amount owed on the mortgage is called a deficiency. For example, assume you owe $200,000 on your home mortgage. If the net proceeds (after deducting selling costs) of the sale are $150,000, then the deficiency is $50,000. In the ideal short sale situation the lender has “forgiven” the $50,000 deficiency and released you from the obligation to pay it. Sounds great so far. But wait! Many people don’t realize that the IRS generally considers debt forgiveness as taxable income. Ordinarily you have to pay taxes on that $50,000 of forgiven debt. Not so great… The Mortgage Forgiveness Debt Relief Act of 2007 temporarily changed those rules, allowing you to exclude from your taxable income the amount of mortgage debt forgiven on your primary residence. If your loan and property qualify under the Act, you don’t have to pay tax on that forgiven debt. It still must be reported on your tax return, but it is not taxable. In order to qualify, the loan must have been used to buy, improve, or refinance your primary residence, and be secured by your primary residence. Second homes and investment properties do not qualify: Debt forgiveness in those cases is still taxable. There’s just one catch — the Mortgage Forgiveness Debt Relief Act expires at the end of 2013. Beginning in 2014, debt forgiveness on your primary residence will again be taxable. Congress could extend the act, but the prospects of that happening do not look good. Many in Congress are focused on reducing the budget deficit, and view the Act as a cost (in missed tax revenue) that should be cut. If Congress does not extend the Act, then you would have to pay taxes on forgiven mortgage debt. That means short sales, principal reductions, and other forms of debt forgiveness could end up costing you tax money that you may not have. Bottom line: If you are considering a short sale of your primary residence, you should do it as soon as possible in order to avoid potential tax consequences. You should always seek professional legal and tax advice before attempting a short sale.
Posted on: Mon, 24 Jun 2013 01:58:59 +0000