How to Avoid the Tax Consequences of a Short Sale

It’s a common situation. You found a great real estate deal, borrowed the money to purchase it from a lender, who was all too willing to give you the maximum amount possible. Then the bottom fell out of the market.

As a result the house is worth half the amount owed on it. If it was a rental, you now have to subsidize the mortgage and it doesn’t cash flow. No matter the circumstances, it no longer makes financial sense to keep the property. Whether it’s a short sale, foreclosure or Bankruptcy, the question you know is lurking in the background revolves around the tax implications when the bank forgives some of the debt. You’ve heard about the 1099’s other home owners have received after a foreclosure or short sale and how the forgiven debt is reported to the IRS as income. So just what are the tax consequences of a short sale or foreclosure?

First some basic principles about forgiven debt. When money is borrowed it is not treated as income and is not taxable. However, when any borrowed money is later forgiven, the money can then be treated as income and the lender will report it to the IRS as income on a 1099. This is true if it’s credit card debt, mortgage debt, or other debt of any kind. In a short sale, the sale proceeds from the home sale are less than the amount of the debt owed so the “short” portion is usually forgiven by the lender (or lenders if there’s a 2nd mortgage on the home) and reported to the IRS as income to you on a 1099-C. If the property is foreclosed on, the same is true – any debt not repaid through the foreclosure sale is often forgiven and the resulting deficient amount is reported on a 1099-A to you as income. Either way, the forgiven amount is reported to the IRS as income to you and has to be addressed on your taxes.

Now the good news. So long as your taxes are prepared properly, a short sale or foreclosure should not result in tax liability in most cases. The key, obviously, is that your tax return must be prepared correctly, otherwise the results could leave you with a huge tax bill and make the situation even worse.

If you’re not sure how to address the problem or are concerned that your tax preparer may not understand the issues, give us a call. Our competitive rates make sense and this is not an area you want to take risks as the IRS is not likely to overlook mistakes.

Call now at (909) 363-4658 in California or (480) 888-7111 in Arizona for more information.


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