Tax Consequences of a Short Sale

Our tip this week is about the possible tax consequences a seller may face as a result of a short sale of his primary residence. Given the current market conditions, many homeowners are faced with the prospect of selling a home where they owe more than its current value. Fortunately for them, the federal government has provided some relief relating to taxes and debt forgiveness. This issue is separate from the Tax Consequence of a Sale that we discussed in a previous tip, as this issue relates solely to potential taxes on the amount of debt forgiven, and not to the tax owed as a result of any gain realized on the property.

The law used to be that if a mortgage lender forgave a certain amount of mortgage debt on someone’s primary residence (for example, in a short sale), the amount that was forgiven was considered income to the borrower and taxable as such. The Mortgage Forgiveness Debt Relief Act of 2007 has changed that. This federal law was enacted on December 20, 2007 and states that mortgage debt forgiven on a borrower’s primary residence is not to be considered income to that borrower and is not, therefore, taxable as such. Keep in mind, though, that this applies to primary residences only - not second homes or investment properties. It also does not apply to any other form of debt like credit cards or car loans. Furthermore, it applies to debt forgiven only in the years 2007-2012 (the time period was extended from 2009 to 2012 per the Emergency Economic Stabilization Act of 2008). After 2012, the law will revert to the traditional provisions of designating forgiven debt as income.

The borrower is still required to report the forgiven debt on his income tax return using IRS form 982, and he should receive a 1099-C form from the lender indicating how much debt was forgiven. If your clients have any questions relating to this, we suggest you direct them to the IRS web site (http://www.irs.gov/) for an explanation (search site using the term "Mortgage Forgiveness Debt Relief Act of 2007") or to their tax adviser.

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