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INCOME TAX CONSEQUENCES ASSOCIATED WITH FORECLOSURE & SHORT SALES
Introduction
The real estate industry, on a large-scale basis, has been flooded with foreclosures, deeds- in-lieu of foreclosure, and short sales of real property. These distress sales and foreclosures are the result of a convergence of tightening credit, falling property values, and the consequences of prior lending practices. Adding insult to injury, owners of real property facing these circumstances, and generally already under financial strain, may be unpleasantly surprised to learn that two types of taxable income can result from a foreclosure, deed-in-lieu of foreclosure, or short sale: capital gains and forgiveness of debt income ( also known as cancellation of debt—COD income).  COD income has also been referred to as “phantom income.” Both types of income can trigger unexpected taxes for the owner. This legal article discusses the income tax consequences to the borrower in the event of foreclosure, in the event the borrower simply transfers title to the lender (deed-in-lieu of foreclosure), and if the borrower sells the property to another in a short sale in which a lender accepts less than the balance due on the loan as payment in full. This article has been updated to reflect the recent California Mortgage Debt Forgiveness Tax law signed by the governor on ... more

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