Will I Have to Pay the IRS If I Short Sale My Home?
If you are considering a short sale to avoid foreclosure, you are probably experiencing financial difficulties. The last thing you want to hear is that you now owe income tax on money you don't have. In some situations, a seller will be required to pay income tax on the forgiven amount in a short sale, yet in other situations, a seller does not incur an income tax obligation.
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Identification
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When a lender forgives a debt, the Internal Revenue Service can hold you responsible for taxes on the forgiven amount. For example, if a bank loans you $50,000, you fail to repay the loan and the bank forgives the debt, the Internal Revenue Service views that $50,000 as extra income. They don't care how you spent the money; they just expect you to pay taxes on it. In a short sale, there are some tax exemptions for the borrower.
Function
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A short sale is a way for a homeowner to sell his home when he owes more than what the property is worth. This typically happens when property values have dropped. If a property owner can't meet his loan obligation, perhaps he has lost his job, or he needs to relocate due to a job transfer, he is unable to sell his home for enough to pay off its debts. In a short sale, the buyer pays less than what the seller owes on the property.
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Considerations
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While your lender must give you permission to list your home in a short sale, this does not mean he is forgiving the unpaid balance of the debt. After the completion of the short sale, the lender might be within his rights to issue a deficiency judgment, demanding you pay the unpaid balance of the loan. If you must choose between paying income tax (due to the lender forgiving the unpaid balance), or a deficiency judgment, you may decide accepting the deficiency judgment and declaring bankruptcy is your best option, as tax debt is not typically discharged during bankruptcy. Consult with your attorney and accountant to help you make the best choice for your situation.
Time Frame
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The Mortgage Debt Relief Act of 2007, as of October 1, 2010, generally excludes forgiven debts from principal residences, for years from 2007 to 2010. Yet, tax laws can be amended or new laws made. Consult with a certified public accountant to see how the current tax laws protect you from tax liability.
Features
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The tax exemptions created by the Mortgage Debt Relief Act of 2007 don't necessarily apply to all homeowners. Current price limits, as of October 1, 2010, are up to $2 million, or $1 million if married and filing separately. You may not qualify for the exemption if the short sale is unrelated to a decline in property value or a decline in your financial situation.
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References
- Photo Credit tax forms image by Chad McDermott from Fotolia.com
