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SHORT SELLER STILL MUST DECLARE INCOME ON SALE!
The Mystery of income you can't spend - but do you have to declare it?
When DON'T you have to report forgiven debt (from a short sale, deed in lieu or foreclosure with release from the lender) as income?
One of the biggest issues that potential short sellers and those in foreclosure ask me is whether they have to get a 1099 for any forgiven debt from their lender.  Without a single exception so far, every debtor (borrower) has assumed that if they can avoid a report from their lender that they are being forgiven a portion of the mortgage debt, they will not have to report any income nor pay any income tax on that forgiven debt.
While it is true that a lender need not report cancellation of debt (see 1099 Reporting - It's the Law), whether or not a lender reports forgiven or canceled debt is not the trigger for the obligation of the taxpayer to include that forgiven debt on his or her income tax return in the year the debt was forgiven.
A taxpayer has two opportunities to avoid the inclusion of the forgiven debt and thus the payment of income tax on that forgiven debt:
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