When a lender agrees to accept less for a property than is actually owed on a property this is called a short sale. When the lender agrees to accept the short sale they have a few options. They can choose to accept the loss, as a tax write off for themselves. Lenders offen do this when they have large profit quarters.
When lenders are not profitable they seek judgments and they want the seller to pay the tax burden. When the lender decides that they do not want the tax write off themselves they agree to the short sale and they issue a 10-99 c to the seller for the difference between what they owe on the property and what it sells for. The IRS has recognized that this is a major issue those who cannot afford their primary home are being taxed for money they have lost. This is a lose- lose situation.
What is the IRS doing to correct this problem of taxation?
The IRS reassured homeowners that, although mortgage workouts and foreclosures can have tax consequences, special relief provisions can often reduce or eliminate the tax bite for financially strapped borrowers who lose their homes.
What options does the IRS offer.
1. Prove insolvency and be released from the debt partially or
completely ( primary residence only).
2. Payment plan to pay the tax back over time
3. Settle the tax debt for less than the full amount.
What does it mean to be insolvent - Simply put you can prove that that your liabilities (debts) are more than you assets (what you own). Go to IRS.gov includes a variety of information, including a worksheet designed to help borrowers determine whether any of the foreclosure-related relief provisions apply to them. For those taxpayers who find they owe additional tax, it also includes a form they can use to request a payment agreement with the IRS. . In some cases, eligible taxpayers may qualify to settle their tax debt for less than the full amount due using an offer-incompromise.
Can this be applied to investment properties or second homes?
The IRS cautions that under the law, relief may be limited or unavailable in some situations where, for example, part or all of a home was ever used for business or rented out.
What happens when the house is sold short?
Borrowers whose debt is reduced or eliminated receive a year-end statement (Form 1099-C) from their lender. By law, this form must show the amount of debt forgiven and the fair market value of property given up through foreclosure. Though the winning bid at a foreclosure auction is normally a property's fair market value, it may not necessarily reflect its true value in some cases.You are advised to check these forms very carefully to make sure the Lender has passed on the correct tax burden.
Question - What kind of tax consequences will I have if I sell my house short.
The Internal Revenue Service that indicates if this is my primary residence and that you are insolvent that the IRS may not make you pay taxes on these items. Please review form 982 from the IRS with your attorney or CPA.
Question - Well if I am also going to have a tax burden in a short sale then I guess I should just let it go into foreclosure.
I can understand why you may think that foreclosure may be a better option.By allowing your property to go into foreclosure that does not guarantee that you will avoid a tax burden, however I see here that the IRS will wait until the property is sold at the courthouse or by the lender and use the current fair market value to determine your tax burden.
Below are some terms and clarification of questions directly from the IRS you can read them for further understanding.
1. What is Cancellation of Debt? If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances.When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the cancelled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.
Here's a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which generally is taxable income to you.
2. Is Cancellation of Debt income always taxable?
Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:
· Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
· Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.You are insolvent when your total debts are more than the fair market value of your total assets.Insolvency can be fairly complex to determine and the assistance of a tax professional is recommended if you believe you qualify for this exception.
· Certain farm debts:If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.The rules applicable to farmers are complex and the assistance of a tax professional is recommended if you believe you qualify for this exception.
· Non-recourse loans:A non-recourse loan is a loan for which the lender's only remedy in case of default is to repossess the property being financed or used as collateral.That is, the lender cannot pursue you personally in case of default.Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.However, it may result in other tax consequences, as discussed in Question 3 below.
3. I lost my home through foreclosure. Are there tax consequences?
There are two possible consequences you must consider:
· Taxable cancellation of debt income.(Note: As stated above, cancellation of debt income is not taxable in the case of nonrecourse loans.)
• A reportable gain from the disposition of the home (because foreclosures are treated like sales for tax purposes).(Note:Often some or all of the gain from the sale of a personal residence qualifies for exclusion from income.) Use the following steps to compute the income to be reported from a foreclosure:
Step 1 - Figuring Cancellation of Debt Income (Note: For nonrecourse loans, skip this section. You have no income from cancellation of debt.)
1. Enter the total amount of the debt immediately prior to the
foreclosure.___________
2. Enter the fair market value of the property from Form 1099-C, box 7. ___________
3. Subtract line 2 from line 1.If less than zero, enter zero.___________
The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C. This amount is taxable unless you meet one of the exceptions in question 2. Enter it on line 21, Other Income, of your Form 1040.
Step 2 - Figuring Gain from Foreclosure
4. Enter the fair market value of the property foreclosed.For nonrecourse loans, enter the amount of the debt immediately prior to the foreclosure ________
5. Enter your adjusted basis in the property.(Usually your purchase price plus the cost of any major improvements.) ____________
6. Subtract line 5 from line 4. If less than zero, enter zero.
The amount on line 6 is your gain from the foreclosure of your home. If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income. If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.
4. I lost money on the foreclosure of my home. Can I claim a loss on my tax return?
No. Losses from the sale or foreclosure of personal property are not deductible.
5. Can you provide examples?
A borrower bought a home in August 2005 and lived in it until it was taken through foreclosure in September 2007. The original purchase price was $170,000, the home is worth $200,000 at foreclosure, and the mortgage debt canceled at foreclosure is $220,000. At the time of the foreclosure, the borrower is insolvent, with liabilities (mortgage, credit cards, car loans and other debts) totaling $250,000 and assets totaling $230,000.
In this situation, the borrower has a tax-free home-sale gain of $30,000 ($200,000 minus $170,000), because they owned and lived in their home as a principal residence for at least two years. Ordinarily, the borrower would also have taxable debt-forgiveness income of $20,000 ($220,000 minus $200,000). But since the borrower's liabilities exceed assets by $20,000 ($250,000 minus $230,000) there is no tax on the canceled debt. Other examples can be found in IRS Publication 544, Sales and Other Dispositions of Assets, under the section "Foreclosures and Repossessions".
6. I don't agree with the information on the Form 1099-C. What should I do?
Contact the lender. The lender should issue a corrected form if the information is determined to be incorrect. Retain all records related
to the purchase of your home and all related debt.
7. I received a notice from the IRS on this. What should I do?
The IRS urges borrowers with questions to call the phone number shown on the notice. The IRS also urges borrowers who wind up owing additional tax and are unable to pay it in full to use the installment agreement form, normally included with the notice, to request a payment agreement with the agency
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