The Mortgage Forgiveness Debt Relief Act was passed in 2007 to protect distressed homeowners from being taxed by the IRS on the debt that was canceled by the lender on the short sale of their home. Prior to the bill being passed, the IRS viewed the deficiency amount as income and the homeowner was taxed.
Investors short selling properties that are not their principal residence need to consult with a CPA to find out if they can claim any exclusion to avoid taxes. One example may include if the investor can prove insolvency.
Distressed homeowners that obtained a Home Equity Line of Credit (HELOC) or refinanced their mortgage after a home purchase may have to pay taxes on the deficiency amount if the monies were not used for home improvements. In the situation the monies were used for improvements, the individual would need to provide receipts for the work completed to the IRS. On the other hand, if a homeowner pulled equity out of the home to take a vacation or put a child through college, taxes may have to be paid on the canceled debt since it was not used to acquire the property.
If you have already completed a short sale on your home, you will likely receive a 1099-C from the bank during tax time; consult with your CPA to appropriately complete your tax return.
Even if taxes do have to be paid on the deficiency amount, short selling a property is often better than foreclosure. Since everyone’s situation is different, talk to your CPA, attorney, or an experienced real estate agent to find out what available options you have to avoid foreclosure.
UPDATE: The Mortgage Debt Relief Act of 2007 applies through 2012.
Colorado Springs Real Estate Agent, Patricia Beck, providing real estate services to home sellers.
