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Tax Season - The Truth About Short Sales and Taxes

By
Real Estate Broker/Owner with Broadpoint Properties Cal BRE #01324959

short sales and income taxWith tax season upon us, lots of folks are wondering about taxes on the forgiven debt associated with short sales and foreclosures. With the end of 2014 came the end of the Mortgage Debt Relief Act of 2007. Although there is talk online of extensions, I have found nothing on the IRS website to confirm that this has been extended again.

As it stands right now, struggling homeowners in certain situations would be responsible for paying taxes on any of the forgiven debt associated with a short sale, a foreclosure, or a deed-in-lieu of foreclosure. The amount of debt forgiven is reported on the 1099-C, and sent to all borrowers. It is the borrower and his (or her) accountant that would be responsible for addressing the debt forgiveness correctly. Specifically, if the short sale lender forgave $50,000 in debt, borrowers were responsible for paying the income tax (on the $50k) at their current tax rate.

Are there any loopholes with short sales and taxes?

At Short Sale Expeditor®, we are not accountants. However, we’ve heard of many short sale sellers that have taken advantage of the insolvency clause and didn’t have to pay any taxes on debt forgiven despite receiving a 1099-C despite that fact that the Act expired already. In addition, California short sale sellers may also have other remedies.

Hot Tips from a Tax Advisor

After discussing the ins and outs of debt relief, insolvency, and the 1099-C with a few amazing Certified Public Accountants, I’ve got some really interesting information to share. These CPAs have advised me that borrowers who receive a 1099-C in association with a short sale, foreclosure, or deed-in-lieu should work with their accountant in order to confirm that the 1099-C was actually completed correctly by the borrower’s lender.

One CPA noted that the mortgage interest was lumped in with the amount of debt forgiven (placed in the same box on the form), and (according to him) that is not the correct protocol. Another CPA noted that often times the entire 1099-C has an inaccurate amount of debt forgiven. He suggests that borrowers retain their final HUD-1 (estimated settlement statement) from both the purchase and the sale, as well as any documentation as to the original amount of the mortgage. In this way, if the 1099-C has not been completed correctly, the borrower and the CPA can demonstrate the correct calculations to the IRS. I’m not sure whether dealing with the IRS or dealing with a short sale lender is easier when it comes to policies, procedures, and the processing of paperwork.

Nevertheless, while many people recommend that you keep your back tax information for at least 7 to 10 years, the IRS only has three years from the date that the taxes were filed in order to conduct an audit. Either way, when it comes to short sales and taxes, it is vital to keep your documentation and take good notes.

Comments (5)

Michael J. Perry
KW Elite - Lancaster, PA
Lancaster, PA Relo Specialist

It's my understanding that the Mortgage Forgiveness Act has been extended thru Tax Year 2016 . Is that correct ?

Feb 06, 2016 10:47 PM
Will Hamm
Hamm Homes - Aurora, CO
"Where There's a Will, There's a Way!"

I am not sure if the Mortgage Forgiveness Act is extended for sure thur 2016. 

Feb 07, 2016 12:05 AM
Bill Roberts
Brooks and Dunphy Real Estate - Oceanside, CA
"Baby Boomer" Retirement Planner

Well Valley Girl, thankfully, there are a lot less of these things these days.

Bill Roberts

Feb 07, 2016 12:51 AM
Kathleen Daniels, Probate & Trust Specialist
KD Realty - 408.972.1822 - San Jose, CA
Probate Real Estate Services

Melissa,  Over the course of my short sale career my clients noted may errors in reporting on the 1099. It is not easy to get the lenders/servicers to correct them ... but they do.

I did not know the IRS only has three years from the date that the taxes were filed in order to conduct an audit.My account recommends retaining files for 10 years.

 

Feb 07, 2016 01:57 AM
Joy Baker
RE/MAX Insight - Salem, NH
So NH RE & Short Sale Specialist

Excellent information, Melissa.  A version of the Mortgage Forgiveness Debt Relief Act was one of the tax break "extenders" that was quietly added into the 2016 Consolidated Appropriations Act which was passed by the House and the Senate and signed by the President in December.

Feb 12, 2016 01:36 AM