Short Sale may be the best alternative if you cannot make your 
mortgage payments, or do not qualify for a modification or are just insolvent without resources. The Short Sale tax consequences need to be strategically planned in advance as they are a key consideration. Using Real Estate Agents and Tax Accountants to assist in making informed decisions could result in saving you thousands. The alternative may result in huge tax obligations that could have been resolved by some simple planning upfront.
Mortgage Tax Relief Act of 2007 has exceptions and rules that must be followed in order to qualify for tax relief. This act currently expires at the end of 2012. The mortgage company will issue a 1099 C if the real property is a Short Sale and if they have forgiven the debt. This is filed with IRS and a copy is sent to your last known address.
The 1099 C form states the Fair market Value of the property at the time of the sale, according to the mortgage company. It is based on the best information they may have at the time of the actual Short Sale which may have been over a year ago. If you did not get this form, IRS did and they will possibly pursue you for taxes if you do not complete the required tax reporting forms.
There are exceptions to the requirement of reporting this income in IRS Tax Code. Some examples are you may not have to report income on your tax return if you discharge the debt in bankruptcy, or you were insolvent before the creditor agreed to settle or write off the debt. The treatment of the Debt with Regard to the Mortgage Debt Relief Act of 2007 will be dependent on many factors some of which include whether the home is your principal residence and if the mortgage was a purchase mortgage as some second mortgages or refinances do not qualify without other considerations under this act.
The preparation of the IRS Tax Form 982, "Reduction of Tax Attributes Due to Discharge of Indebtedness", is a form that needs planning in advance of your short sale and the assistance of a Tax Professional to make certain you meet the IRS requirements for insolvency. You should consult a qualified tax and legal counsel to see if these circumstances apply prior to entering the short sale contract to sell your home so you know and understand your tax ramifications. The sequence of Insolvency, and Short Sale proceedings could mean thousands of dollars to you if not handled correctly and in the proper sequence. Correctly handling these could save you thousands in income tax obligations and save you the cost of filing Bankruptcy to eliminate the tax burden created by Debt Forgiveness.
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