Short Sales and Tax/Income Implications

This past weekend I had an agent ask me about the tax/income implications of a short sale. She said that her seller was concerned about both the tax/income implications and the future possibilities of a deficiency judgment against her seller. To answer the questions let’s begin with an understanding of the complexity of short sales and possible tax/income implications.

First, let me state that I am not an attorney nor a tax or real estate accountant; and these statements or facts should not be construed to represent a solution to any questions you or any of your clients concerns; however, if a referral to an ‘expert’ is required, TEAM ShortSale will refer to you one of our qualified legal or tax ‘experts’.

When the question of a homeowner wanting to sell their home and avoid a senior or junior lien holder pursuing a deficiency judgment there is protection provided under Senate Bill 931; and subsequent Senate Bill 458 which expands upon the previous short sale anti-deficiency laws. In other words, upon accepting the terms of the short sale, junior lien holders now agree to waive their right to pursue a deficiency judgment. The borrower cannot be required to owe or pay for a deficiency in a short sale. These two California Senate Bills (SB-931 & SB-458) coupled with The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. And now as of 2013 the State extended protection under the passage of the California Homeowner Bill of Rights.
 
If you are a homeowner whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2013, you may be able to claim special tax relief and exclude the debt forgiven from your income.

Here are 10 FACTS the IRS wants you to know about Mortgage Debt Forgiveness (Taken from IRS.gov). The Mortgage Forgiveness Debt Relief Act of 2007.

1.  Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.
2. The limit is $1 million for a married person filing a separate return.
3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt   forgiven in a foreclosure.
4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.
5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.
6. Proceeds of refinanced debt used for other purposes -- for example, to pay off credit card debt -- do not qualify for the exclusion.
7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.
8. Debt forgiven on second homes, rental property, business property, credit cards or car loans do not qualify for the tax relief provision. In some cases, however, other tax relief provisions -- such as insolvency -- may be applicable. IRS Form 982 provides more details about these provisions.
9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.
10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

The most important thing to remember is pay particular attention to the Short Sale Approval Letter you receive from the lender, and if you are not clear that your client has been offered relief from the debt under The Mortgage Debt Relief Act, immediately seek legal counsel. “I’mjustsayin’ TEAM ShortSale”