Will I Have to Pay Taxes if I Short Sale My House? – Federal
June 28, 2012 Leave a comment
From my knowledge of short sales, here is pretty much how federal taxes relate to short sales:
When you do a short sale, your lender agrees to settle the debt on the property for less than the total they are owed. The IRS allows them to write off this loss. To write off this lose, your lender will send you a 1099-C after the short sale.
The IRS views “debt relief” to be income for tax purposes. So, if your lender writes off $70,000 on your short sale, they will send you a 1099-C for that amount, and you would include that when you file your income taxes. The “C” stands for “Cancellation of Debt” and per law, cancelled debt is taxable as income.
There exist a few exceptions that exclude people from having to pay taxes on their short sale.
As a result of the Mortgage Tax Debt Forgiveness Relief Act signed into law in January of 2008, most homeowners who do a short sale on their primary residence pay no taxes on the loss that their lender incurs in a short sale. This law is currently set to end the end of year 2012.
Homeowners who have taken out cash from their home but have put that money back into their home to improve their home, also are excluded from taxes on the short sale.
All other short sale situations; For example, if you pulled cash out on your primary residence but it was spent on something other than upgrading your home or if your short sale is on a second home or investment property, end in a taxable event unless you qualify for the “Insolvency” exclusion. The IRS does not require you to pay taxes on the loss the lender takes in a short sale if, at the time of the short sale, you are insolvent. Insolvency means your debts (including your mortgage) exceed the value of all your assets.
For more on insolvency, I suggest you check with your CPA or accountant or visit the IRS website and look up IRS Form 982, which is the IRS form for debt relief and short sales. An explanation of “Insolvency” is given on this form.
Every situation is different. I recommend you review your specific tax scenario with your CPA, or accountant and have them answer any tax questions that you have. I am not a tax advisor and do not dispense tax advice.
Later on, I’ll cover how short sales relate to California State taxes
If you are curious to know more about short sales, contact me…I’m on your team!