Short Sale Tax Consequences... Will the IRS Forgive the 1099 Income?

The following useful article was forwarded to me by Steve McMichael:

If being in default and the threat of foreclosure aren't troubling enough, the thought of the IRS coming around after the fact is sure to keep sellers up all night.  They have all heard the stories of being tracked down by the tax man to pay taxes on "forgiven debt."  To them it's like a bad dream turned into a nightmare, all summed up and justified by a bunch of letters and numbers.  But not every code section is necessarily a 4 letter word.

Code Sec 108(a)(1)(B),(C) - better known as 1401, means everything to some homeowners in today's market ... but it only has meaning in light of HR 3648.  Then again, Section 163(h)(3)(b) is really the key to the whole thing.  Make sense to you?

It doesn't to your homeowners either.  Staring foreclosure in the face they want to know if there is anything they can do.  Can you sell their house before the deadline?  In most cases your answer would be no because they are completely "upside down" but there are cases in which a short sale could work.  And when you broach that subject one of the first questions they may ask is "what is our tax liability if we agree to a short sale?" 

While the correct response is that you are neither a tax lawyer nor a CPA, you need to be able to let them know that if they qualify there are some options that may resolve that issue.  And it all ties back to December 20, 2007, when President Bush signed into law a new measure giving tax breaks to homeowners who have mortgage debt forgiven.  With the passage of the Mortgage Forgiveness Debt Relief Act of 2007, a taxpayer does not have to pay federal income tax on debt forgiven for a loan secured by a qualified principal residence. 

Why is this so important?  In most instances,  debt that is forgiven or cancelled by a lender must be included as (ordinary) income on the seller's tax return and is taxable.  There are a number of terms within the bill that are central to the issue, such as "Acquisition Indebtedness" - and you need to know them. 

And don't forget December 31, 2009.  That's the date when this tax break expires.  It only applies to debts discharged from January 1, 2007 to December 31, 2009.  And tell your sellers that "being insolvent" as a result of bankruptcy doesn't count.  The Short Sale is a powerful tool in the hands of a qualified real estate professional.

To learn more about the Short Sale process and how you can successfully move into this lucrative market, consider taking the new Certified Short-Sale Professional (CSP) from RealtyU.   The course has captured 11 years of "in the trenches" experience and put them into a first class, interactive, online format.  To overview the course and find out more about Short Sales, you can visit www.realtyu.com.

Thomas M. Mitchell : Tom is a seasoned professional in the real estate industry with extensive experience in the creation and development of offline and online courseware. He has wide-ranging 30-year background in all phase of the real estate industry. Tom manages the Home Staging Council, the Luxury Home Council and the RealtyU School Network, all part of the RealtyU Group of companies. Mitchell@realtyu.com Other Articles »