Do I have to pay Income Tax if I Short Sale?

Great Question…. Their are many different scenarios that apply to this question, I’ll try to answer this in lehman’s terms.

When you Short Sale your home you and your bank are agreeing to settle the debt less then what you owe them.  The IRS allows the bank to do this and write it off as a loss, which is the reason your lender will send you a 1099-c tax form when it closes.  The “debt relief” is considered to be income for tax purposes. For example, if your bank agrees to Short Sale your home and is taking a $100,000 loss from the difference you owe to what you sell it for they will send you a tax form 1099-c for that amount and you will need to include that when you file your taxes in April.  Anytime you file taxes on a “cancellation of debt” the law states that cancelled debt is taxable.

In January of 2008 President George W. Bush signed into law the Mortgage Tax Debt Relief Act which states that homeowners who bought a house as a “primary residence” and did not take cash out of it will NOT have to pay taxes on the amount the IRS taxes you on your 1099- C.  If you did take cash out of the home but used it to make home improvements (pool, upgrades, new roof…..ect) you will also not need to pay taxes on the amount lost.

If you took cash out of your house to buy new cars, have lavish weekends in Las Vegas that rivaled the move “The Hangover”,or took cash out to buy a second home or investment property then the result is taxable unless you qualify for the “Insolvency” exclusion.

The government (IRS) does not requires you to pay taxes on a loss the bank/lender takes in a Short Sale if at the time you Short Sold you were Insolvent.  At the time of your Short Sale if you have more debt then you have assets, then you are considered Insolvent and will not be required to pay back the taxed loss from the lender.

I get this question all the time and answer it exactly as I have written above.  I always highly reccomend that all sellers consult with a CPA on this matter.  For more information go to http://www.MyShortSale.net or call 1-800-706-7636 extension #2 for a specific Short Sale Packet on your home.