Income Tax after a Short Sale
The income tax that occurs after a homeowner goes through a short sale should usually be expected, and can present a new set of problems even when some debts are canceled outright. The good news is that the taxes that go along with a debt cancellation may not always be taxable under some circumstances. Selling your home for a loss may seem like a cruel thing to tax, even by government standards, so the “Mortgage Forgiveness Debt Relief Act” has been put in place. People who take out short sales or foreclosures are the first and foremost beneficiaries of this act, so long as they meet certain criteria.
The Mortgage Forgiveness Debt Relief Act
Enacted in 2007, the Mortgage Forgiveness Debt Relief Act allows the exclusion of income tax that comes as a result of mortgage or foreclosure modifications to your home. In plain English, this means that there are usually no taxes on any forgiven or lowered debts if you take out a short sale or foreclosure on your home, upon qualification.
Homeowners must still abide by certain criteria in order to take advantage of this:
●First of all, the debt relief or cancellation needs to have taken place in 2007 or later. If you took out a short sale around this time period, then check again to see if you are eligible.
●If your debt was secured in order to fund your primary home or place of residence, then you may not have to pay income tax after a short sale. “Qualified Principal Residence Indebtedness” is another term for securing a debt by the home.
●Some debts that were taken out to renovate a home may fall under the acceptable threshold of the Mortgage Forgiveness Debt Relief Act.
●The maximum amount of indebtedness covered by this act is $2 million if married or $1 million if you are filing separately from a tax year.
●If you are taking out a short sale on a rented property, vacation home or a second home, then it might be possible might qualify for an exclusion from income, but typically has to be claimed.
Be aware that selling your home at a loss to gain debt forgiveness will constitute as debt cancellation. A lender who cancels a debt on the count of dissatisfaction will place the cancellation of debt income on you. You will also have to report the forgiven debt on your tax return when you file for one. You may need to call up your nearest IRS office in order to get more details about the Mortgage Forgiveness Debt Relief Act; anything involving a short sale can be a little tricky to get around. Some special cases may also apply for some homes and homeowners.
Income Tax on Short Sales and Foreclosures
As a rule of thumb, short sales will be taxed under the same rules and regulations as a foreclosure would be. This is because recourse debt cancellation may not always be satisfied when a property is short sold; proceeds which are turned over to pay off a debt may still end up taxable as “cancellation of debt” income.
Short sales can affect income taxes in a variety of ways:
●The cancellation of debt income taxes may also be possible if the debtor is somehow deemed insolvent. This may not be the same as declaring bankruptcy or going for a strategic default, especially when dealing with real estate and short sales.
●A short sale can still end up taxable by federal law if you used the mortgage of your house to pay off medical bills, credit card debts or to buy other properties. Deficiencies which are similar to these cases may still be taxable, too.
When legally insolvent, the cancellation of debts is not always taxable. According to the IRS, other forms of debt income, whether or not it involves a short sale, are exceptions to income taxation laws:
●Qualified principal residence indebtedness, as outlined in the Mortgage Debt Relief Act of 2007, are exempt from income tax, so long as the criteria are met.
●If you own a farm, and if you took out debts to operate it, then canceled debts are not subject to income taxes. To be eligible for this kind of tax exemption, at least half of your income three years prior should have come from farming operations. The people you gained a debt from should also be actively engaged in legal money lending.
Income tax can sooner make your bid for a short sale a bigger headache than you initially thought. With a little prudence and research on government tax laws and regulations, you may be able to save yourself even more money in the long run. After all, a short sale is intended for families in hardship. Choosing the right short sale Realtor in the beginning of your short sale will typically greatly benefit the outcome of your short sale while also educating you about the short sale process from beginning to end. Always seek legal advise and representation in all legal and tax matters. The first place to start in the short sale process is to choose an experienced Realtor like Dale to guide you.
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