I have written several posts advising homeowners in trouble with their mortgage to consult both their attorney and their CPA before agreeing to a short sale.
The Wall Street Journal has written a good post highlighting the potential tax impacts of doing a short sale.
Homeowners could be tax on the gain in their property even if they do not get any cash out of a short sale which is how they always work. Say someone bought a home for $200,000 several years ago and at some point refinanced for $350,000. The property was then sold via short sale and the lender agreed to take say $300,000 as pay off for the loan. This homeowner could be charged tax on the $100,000 gain since they bought at $200,00 and effectively sold at $300,000.
In addition in the above example, assuming the lender forgives the $50,000 debt not collected through the short sale (lender owed $350,000 and received $300,000), the homeowner will have a taxable income of $50,000.
It is not the intent of this post to give specific concrete advice about short sales but rather just alery everyone that there are complex legal and tax issues that must be dealt with. Do not agree to anything before you get this advice. A mistake here could result in a big tax liability.
5 responses so far ↓
1 Teresa // Aug 5, 2009 at 3:29 pm
I heard that there was possible legislation passed in California that would negate tax on forgiven debt. Do you know anything about that?
2 Arn Cenedella // Aug 6, 2009 at 6:34 am
Teresa
good question.
my understanding is as follows:
CA did have a law in effect until Dec 31, 2008 that eliminated any tax on forgiven debt for owner occupied properties.
this law expired at the end of 2008.
with CA’s budget crisis, the law was not automatically renewed.
perhaps new legislati0n has been passed but i am not aware of any.
the Fed government still does not tax forgiven deby as income on a personal residence.
the laws are complex and constantly changing which is why i strongly encourage people to obtain legal and tax counsel before agreeing to short sale.
hope this helps.
Arn
3 Melodie Benson // Dec 11, 2009 at 5:20 pm
I believe the CA Law you are referring to is H.R. 3648: Mortgage Forgiveness Debt Relief Act of 2007 which is in effect until December 31, 2009.
My understanding is previously, if someone sold their home “short”, or negotiated a “short sale” (sold their house for less than what was owed to their lender, and the lender simply forgave the difference) the IRS considered the debt that was forgiven to be income, taxable income no less, and that homeowner who had typically just been going through hard times was slapped with a bill for the taxes owed on this “phantom income”.
What this bill does is remove the taxation requirement. In addition, this bill also extends the tax deductibility of Mortgage Insurance through December 31, 2010.
4 Natasha Bennoch // Feb 13, 2010 at 5:11 am
Is ther by any chance releif on shart sale taxes in state of Mass?Forgiven $67,000. What would be the tax on it?
Thank you,Natasha
5 Arn Cenedella // Feb 13, 2010 at 9:19 am
Natasha
I live in California so I am not familiar with Massachusetts law. I am sorry.
I believe the US does not tax on forgiven debt.
Until the end of 2008, California did not tax on forgiven debt but now California does.
In terms of how much tax, you need to determine what you Massachusetts tax bracket is. The $67,000 will just be added to your other income and the $67,000 will be taxed in the same way as any other income. So if the Massachusetts tax rate is 5%, then your tax will be 5% of the $67,000. I am not giving you legal or tax advice just speaking in general terms. My best advice is to contact a Massachusetts CPA and the CPA can calculate the numbers exactly. If you are lucky, maybe Massachusetts follows federal law and the tax will be forgiven. Not sure, ask a local CPA. Good luck.
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