When Hard Times Hit Close to Home: Short Sales and Your Taxes

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Although the economy is showing signs of life is most parts of the country, there are still some consumers struggling to regain financial footing lost in the recession. Plunging home values, long stretches of unemployment and ongoing under-employment can wreck havoc on your finances. If you’re contemplating a short sale of your home, there are possible tax implications.

What is a short sale?

Let’s assume your mortgage balance is $500,000 and you can no longer continue to make your mortgage payments. Your lender agrees to allow you to sell your home for $450,000, which is $50,000 less than your loan balance. Once the sale is complete, you’re out from under your mortgage and your home.

What will happen next?

The mortgage company or lender cancels the remaining $50,000 as part of the short sale. They will issue a 1099-C Cancellation of Debt form to you at the end of the year, and you will need it to file your taxes.

How will it affect my taxes?

Typically when a debt is cancelled (e.g. car loan, credit cards) you’ll need to claim the cancelled debt as income. For example, if a credit card company cancels an old $5,000 credit card debt, you’ll need to declare that $5,000 as income on tax day.

In theory, the same rule applies for any cancelled mortgage debt due to short sale or foreclosure. However, there are two key  exceptions to that rule:

  • Insolvency: If your debts (liabilities) exceed your assets, you’re considered insolvent and the cancelled debt is exempt from being taxed as income.
  • Bankruptcy: If the short sale was discharged through a bankruptcy, it isn’t considered taxable income.

Dealing with a short sale is complex, even for the most financially sophisticated consumer, so if you’re contemplating a short sale or if you’ve already had a short sale of your home, it’s time to enlist a tax pro who can advise you based on your individual income circumstances and tax scenario.

He or she can provide valuable input regarding the changes in your tax scenario and  how to reduce your overall tax liability.

If you’re facing IRS collection or any other serious tax matter, we have tax pros on staff who can help. Get started today by either giving us a call at (888) 224-3004 or by clicking the white “start chat” button on our homepage. Don’t go it alone. We can help.

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