Tax Consequences of Short Sale Vs. Foreclosure
A foreclosure is a repossession of a property by the lender because of a default by the buyer on a mortgage payment. Conversely, a short sale is a settlement with a lender that halts a foreclosure, if successful, and the property is purchased by a new buyer. Neither option is exempt from tax penalty in most cases, but the way these two methods are taxed are different.
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Residency
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If a property is your principal residence and it is sold in a short sale or foreclosed on, the owner is exempt from tax penalty. But if the property was an investment property or second home, there are tax penalties for both options.
Foreclosure
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A foreclosure sale will be taxed according to the deficit the homeowner has left on a property. For example, if a property was worth $200,000 and it was sold in a foreclosure auction for $150,000, the tax liability to the previous homeowner is normally $50,000.
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Market Value
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If the market value of the property decreased before a foreclosure sale, much of the tax penalty is forgiven. For example, if a property had a loan on it of $250,000, but the property was worth $200,000 and sold for $150,000, the deficient of $100,000 is forgiven.
Deed in Lieu of Foreclosure
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A deed in lieu of foreclosure is still recorded as a foreclosure sale. In these cases, the homeowner is still responsible for the taxes on the deficient between the foreclosure sales price and the loan amount.
Short Sale
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When a bank is offering to settle a debt in a short sale, there is typically not a recorded deficient. Because of this, the tax liability is significantly decreased.
When a Sale is Less than the Settlement
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When a short sale is accomplished for less of the sales amount the bank was willing to take from the homeowner, the homeowner will be responsible for tax on the difference.
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References
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Comments
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rlisonbe
Nov 12, 2010
There are so many different scenarios that could be your personal case that it is impossible to explain them all in an article. Everything the author said is true but can be very misleading. If you don't have a knowledgeable accountant... get one! He will not charge you a fee for returning a call or E-mail about your specific situation. I spent hours studying shortsale information online and still did not have an answer. My accountant answered my questions perfectly in two minutes. Don't waste your time on the internet.
