Short Sales and Taxes: The Real Story

July 20, 2010 - PRLog -- Following questions surrounding Short Sale credit effects, short sale sellers are now faced with another issue: that of tax implications. The debt forgiven in a short sale may be subject to income taxes, which not all homeowners are prepared for. For this reason, experts recommend reading up on state and federal rules regarding short sales, taxes, and cancelled debt, so that sellers aren’t caught off-guard when tax season comes around.

Short sales allow a homeowner to sell off his home and use the proceeds to pay his lender, even if the fair market value isn’t enough to cover his balance. This is usually an option for those whose homes have depreciated so much that they owe more than the home is worth. The difference, usually forgiven by the lender, is considered income by the Internal Revenue Service (IRS) and is therefore subject to the corresponding tax.

As few homeowners were aware of the rule, many were caught unprepared in the tax season following the short sale. This has prompted the government to introduce the Mortgage Debt Relief Act of 2007, which exempts homeowners from tax implications following short sales, deeds-in-lieu of foreclosure, and other mortgage workouts. Not all borrowers are qualified, however, so it still helps to get informed before taking any steps.

Under the Act, Short Sale Sellers are exempt from taxes for forgiven debts of up to $2 million. If the seller is a married couple filing separately, each spouse is exempt for up to $1 million each. Only primary residences are covered by the act, so any debt discharged on rental properties and second homes will still be taxable after a short sale. Also, the debt must not have been cancelled in exchange for a service or product on the borrower’s part.

The Mortgage Debt Relief Act of 2007 was initially planned for debts forgiven through 2009. However, with the Emergency Economic Stabilization Act of 2008, the program was extended three years and is now open to debts forgiven from 2007 to 2012. Experts advise borrowers to seek short sale assistance early on, as short sales can drag on for several months. The 2012 deadline provides ample time to complete the sale, but it always helps to leave room for error.

The tax relief program is expected to get more borrowers into short sales, especially as the government’s loan modification program has not been able to help as many struggling homeowners as expected. The Home Affordable Modification Program (HAMP) was launched in 2009 in a bid to help homeowners reinstate mortgages in default, but as banks struggled to keep up with the demand, it fell short of its initial goals.

The Home Affordable Foreclosure Alternatives (HAFA) program, launched in April 2010, is meant to help homeowners who have failed to get loan modifications find other foreclosure alternatives. As of midyear, the program has already facilitated short sales for thousands of homeowners who would otherwise have gone into foreclosure. The tax exemption should encourage many more to pursue real estate short sale instead of letting lenders foreclose.

For more information on Short Sales and Taxes please visit http://www.shortsalesafe.com

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Short Sale Safe offers a full range of short sale services for buyers and sellers. Our agents have several years of short sale experience, both on the buy short sale and sell short sale .