Debt Forgiveness and Tax Implications of a Short Sale
When considering the tax implications involved in doing a short sale, it is important to understand how deficiency and debt forgiveness figure into the process.
The deficiencies associated with both short sales and foreclosures are treated as debt forgiveness by the lenders and, more importantly, by the IRS.
Debt forgiveness is essentially a form of income that may result in additional tax liability unless the borrowers are exempt under Mortgage Forgiveness Debt Relief Act of 2007.
** Updated for tax year 2015 **
Effective in 2015 tax year, any forgiven debt stemming from a short sale, foreclosure, or deed-in-lieu of foreclosure will be exempt from state income taxes.
Since 2007, forgiven debt (including that which is a result of a short sale) has not been subject to State of Maryland taxation due to the federal Mortgage Forgiveness Debt Relief Act.
The Mortgage Debt Relief Act:
- Excludes as income any debt discharge up to $2 million.
- Applies only to the homeowner’s principal residence.
- Initially only covered tax years 2007-2010.
- Has been extended through 2016.
- May apply to debt discharged in 2017, if there was a written agreement made in 2016.
Under the Act, the IRS is prevented from taxing distressed homeowners on the amount of debt forgiven in a short sale.
A short sale, in most cases, yields a significantly lower deficiency than a foreclosure.
Keep in mind the possibility of the Mortgage Relief Act not being extended in the coming years. If the Act was not extend, homeowners in distress, would lose the benefits currently provided by the Act.
If you’re considering a short sale, and would like to learn more about the tax implications involved, please contact us today for a free, no obligation consultation about your options.
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If you’re a homeowner in distress, we recommend that you consult a trusted tax adviser in regards to the details having to do with debt forgiveness and the tax implications of a short sale.