Short Sales and Your Tax Liability
There is a lot of confusion surrounding the tax liability in regards to the forgiveness of debt when it comes to a short sale.
First off it is important to state you are concerned about the tax liability in a short sale, you should definitely talk to your accountant. Nothing surpasses professional advice.
In 2007, President Bush enacted the The Mortgage Debt Relief Act of 2007. Generally it allows taxpayers to
exclude income from the discharge of debt on their principal residence.
Debt reduced through mortgage restructuring, as well as mortgage debt
forgiven in connection with a foreclosure, qualifies for the relief.
If you have re-mortgaged your home and have taken out cash in the refinance, you do not fall under the act. There could be tax liability in this circumstance.
The other thing to consider is if you are insolvent, then debt forgiveness is not taxable income. This has always been part of the IRS tax code. there is an insolvency test that is followed. Simply stated, if your total indebtedness is more than the market value of your assets than you are insolvent.
Most people in a short sale situation would probably fall into this category. Again, if it is important to you talk to an accountant with experience in this area to see if you will have a tax liability. In most short sale situations you are better off owing the tax liability than facing the deficiency judgment.
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