Tax Consequences for Short Sales

The Mortgage Forgiveness Debt Relief Act of 2007 allows taxpayers to exclude from income forgiven debt on their principal residence.  This applies in a foreclosure, a short sale, and even a loan modification. This law applies to debt forgiven from the present through 2012, and covers up to $1 million if an individual and $2 million for a couple who is married and filing jointly.

The amount of debt forgiven reduces the taxpayer’s basis in the home. More information can be found in IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments.

1. What is Cancellation of Debt?
When you borrow money from a commercial lender, and that lender later forgives some if not all of the debt, the amount forgiven must be considered income for tax purposes, depending on the circumstances.  From a tax perspective the forgiveness is seen by the IRS as a gain since you no longer have an obligation to pay the lender.  The lender will report the amount cancelled to you and the IRS on a Form 1099-C.

2. Is Cancellation of Debt income always taxable?
Not always. The following are important exceptions.
* Bankruptcy: Any debts discharged through bankruptcy are not considered income.
* Insolvency:  If your total debts exceeds the total fair market value of your assets, you are  considered insolvent.  Insolvency can be a very complex issue for a financial perspective, so please contact a tax professional if you believe that you qualify for this exceptions.
* Forgiveness of debt on a short refinance (loan mod) or Short Sale: See above and only for a personal residence.  

3.  I don’t agree with the information on the Form 1099-C that my lender provided me.  What should I do?
Please contact your lender.  They should correct the information on the Form 1099-C if the information is correct.

4. Are there any other resources for tax help?
If you are having difficulties resolving a tax problem with the IRS, the Taxpayer Advocate Service may be able to help. Please call  TAS toll-free case intake line at 1-877-777-4778, TTY/TDD 1-800-829-4059 for more information and help.
You may also qualify for help from a Low Income Taxpayer Clinic (LITC).  LITCs are independent organizations that represent low income taxpayers in tax disputes with the IRS. Find information on an LITCs in your area.