Short Sales, Taxes and the IRS
UPDATE: 12/20/2007 - President Bush signs The Mortgage Forgiveness Debt Relief Act of 2007
UPDATE: 12/14/2007 - Senate Passes Mortgage Forgiveness Debt Relief Bill
Given the current state of the San Diego real estate market, it is no surprise that the most frequently asked question we get revolves around the potential tax consequences of a short sale. A short sale occurs when a property is sold for less than what is needed to pay off any loans on the property. When this debt is cancelled, the lender’s obligation by law is to file a 1099-C with the Internal Revenue Service.
The IRS has published Questions and Answers on Home Foreclosure and Debt Cancellation. The following excerpt should provide a starting point for questions to be asked a CPA or tax attorney:
1. What is Cancellation of Debt?
If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender.When that obligation is subsequently forgiven, the amount you received as loan proceeds is reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form1099-C, Cancellation of Debt.
2. Is Cancellation of Debt income always taxable?
Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:
Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value ofyour total assets. Insolvency can be fairly complex to determine and the assistance of a tax professional is recommended if you believe you qualify for this exception.
Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income. The rules applicable to farmers are complex and the assistance of a tax professional is recommended if you believe you qualify for this exception.
Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default.
Overview of the debt forgiveness bill - Short Sale and Phantom Tax Debt Relief Overview
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42 Responses to “Short Sales, Taxes and the IRS”
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Think that most people forget about the tax issues with a short sale. Actually most people don’t really look at the whole picture either way, they are just worried about getting out of the home. Good information!
Thanks for getting good information out there. The form to file with the IRS to prove insolvency (see Question 2 above) is IRS Form 982. It must be filed in the year that the transaction closed.
Hi, Bob. Thanks for the link back but it isn’t working. Looks like the “dot” between www and karengeselle.com was left out. My mistake.
Hope you had a Merry Christmas.
Thanks Karen. Got you covered.
Have a great New Year.
Hasn’t their been some recent legislation changes regarding this matter?
I was “told” by the mortgage broker that my loan is non-recourse. How can I determine if this is in fact the case?
In the loan docs there is a section that says:
Sequrity:
X You are giving a sequrity interest in the property being purchased.
Other (describe)
The “other” box is not checked & no other property or asset is described.
This is the only thing I can find in the docs regarding the lenders colateral.
What is your opinion or how can I get e realiable determination on this? (don’t really have $ for a lawyer)
Thx,
Tom
I sold my house to prevent foreclosure. There was still a balance owed on the 2nd mortgage after the short-sale and now, that mortgage company is trying to come after me for the balance owed. Do I fall under this new law of Bush? Can I get this debt relieved? I can’t afford to pay them anything and they are ruining my credit.
Tom, when we do a short sale and the lender says the loan is non-recourse, we ask them to put in writing that they will not seek a deficiency and that the terms of the short sale include release of the lien and the underlying debt.
Lisa, the law applies to tax relief on forgiven debt. If the lender did not forgive the debt, then it doesn’t apply.
You need legal advise as to whether or not the 2nd can legally come after you. If they can’t, then the law would apply.
THanks for the tip, Bob.
At this stage,It is the lender’s position that the loan is recourse.
The lender has agreed not to persue deficiency and will release both the lein and the debt..
The issue at hand is potential taxation of the 1099 amt.
This is a loan for aquisition that is being forgiven. How can I determine if the forgiven debt will be taxable?
Thx,
Tom
Hello, I have to make a decision if to go for a short sale or not. I purchased a condo and now I know that I would have to pay tax on the difference of the short sale and the amount owed. Do you think that I should wait a little more, try to refy . If I do a shorsale how many years will my credit affected?
How much time will I have to pay the taxes?
I am not completely aware of your entire current status, but from my research the foreclosure will pull at least 200 points as were the short sale will be just 40-60pts please contact an attorney I looked through laws to find provisions to help those in risk of being charged through a 1099 for taxes
I try not to be over the top here, and I do not like absolutes in areas that are nothing but gray. Credit scores are a gray area. Credit scores are an algorithm. Assuming that the same action affects everyone the same is a mistake.
Here are two real life examples of people that started with FICO scores above 750. One saw a 100 point drop after the 30 day late and then another 30 point drop after the 60 day late.
The NOD has not been filed. That will be another hit.
The other person completed the short sale. There were hits at 30 days late, when the NOD was filed, at 60 days, and when the sale was forgiven. The short sale (which I did not handle) was reported as a charge off and the final hit happened. FICO score now in the 500s.
If someone had started with a 600 FICO, the end result could be the same, but each credit hit would be a smaller number.
The bigger difference is the recovery period. The foreclosure stays on the credit report for up to 10 years.
My husband and I just closed this morning on our townhouse and it was a short sale. This property was on the market for 4 years! All said and done, we put about 40k of our own money into it. The bank accepted almost 70k less that what we owed. If you are thinking about short selling, be persistant. Our lender told the work-out dept. not to answer there phones. Our short-sale came 5 days before foreclosure.
There is SO MUCH misinformation swirling around the Internet about short sales, deed-in-lieu and foreclosure and how they impact one’s FICO score! It’s a shame, because Short Sale Consultants gleefully tell homeowners that if they would only short sale, their credit problems will be eliminated or minimized. Not true! Bob is correct: credit scores are an algorithm, meaning that they consist of numerals–not English explanations–to develop a score. Thus, a short sale, deed-in-lieu and foreclosure all show up as Score Factor Code #22–”serious delinquency [short sale/deed-in-lieu], derogatory public record [NOD/foreclosure] or collection agency filing.” Regardless of what else is going on in the borrower’s credit history (maxed out credit cards, credit history too new or too thin), the hit for any of these three events is the same.
The biggest difference is the recovery period–insofar as FICO is concerned, that is. With respect to future qualifying at an institutional lender, the seasoning period for short sale, deed-in-lieu or foreclosure is 24-48 months, depending on the lender.
In any event, it’s absolutely wrong to say that foreclosure is X point, or short sale is Y point or deed-in-lieu is Z point hit to one’s FICO score.
Catherine, thank you for chiming in and adding some clarity to the issue.
Very informative post and great credit score explanation. I guess we will see all the “credit repair” companies coming out of the woodwork again.
Already seeing them crawl out from under a few rocks, Jersey.
I own two properties that are valued under market and I need to short sale. I lived in both of them for the requisite 2 years of the last 5 years, as described in Sec 121 of the tax code. Does this mean I can claim the exemption of the mortgage debt relief act of 2007?
what is a sheriff sale? is property recoverable before and or after sheriff sale?
Thomas, the right of redemption varies from state to state.
I went through a divorce last summer and because of the market, we owe more then what our house is worth. After trying to refinance and explore rental options, we have decided to go with a short sale. However, I’m hearing a lot of different information and am honestly concerned. If the bank accepts an offer 50k less then we owe, is the debt split between us (both on mortgage)? And if so, could I have a potential agruement for a different split given the terms of our divorce decree? (He pays 70% of mortgage, I pay 30 until the sale of home)
Also, if my debt is more then my assets, what is considered an asset other then investments? How would I qualify for what Bush passed and not have to pay the difference at tax time next year?
Lisa Miller said: “I sold my house to prevent foreclosure. There was still a balance owed on the 2nd mortgage after the short-sale and now, that mortgage company is trying to come after me for the balance owed. Do I fall under this new law of Bush? Can I get this debt relieved? I can’t afford to pay them anything and they are ruining my credit.”
Lisa - what State are you in? Was your 2nd mortgage taken at the SAME time you purchased your house, or was it a re-finance?
Also, when you sold your house through a Short Sale the 2nd mortgage company would have had to provide a Short Sale Approval/Release of Deed letter agreeing to accept X at closing for release of their lien against the property.
In some cases, the wording in the letter states something to the affect that while they are agreeing to release the lien, the promissory note portion of the mortgage (i.e. your promise to pay back the loan) remains in affect.
Some lenders even require sellers who want to do a Short Sale to sign ‘new’ promissory notes, typically for the full amount of the remaining debt.
I suggest you check your paperwork and contact a qualified attorney for legal advice on this subject.
Good luck!
Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default.
So - does agreeing to do a Short Sale qualify as ‘in case of default,’ and potentially allow the lender to persue you personally even if the loan is non-recourse. For example when you sign a promissory note to pay off the difference because that was the only way the lender would agree to do the Short Sale?
Or doesn’t the very act of doing a Short Sale mean that the lender didn’t use their so called “lender’s only remedy in case of default is to repossess the property being financed or used as collateral.”
So in essence…a Short Sale isn’t technically a default - which could open the homeowner up for being persued personally even in States such as CA with non-deficiency laws and even on non-recourse loans?
This is Lisa again. I reside in Kansas, no this was not a re-finance. It was a second mortgage at the time of the first mortgage. 80/20 split. Yes, you’re so right, the wording in the letter confused me and I signed it for the lender to release the lien on the house so I could sell it and now they are harassing me for the remaining balance owed. I don’t believe I signed a promissory note, but maybe I did. I will try to contact a lawyer for advice, but this is crazy. I can’t afford to pay on a loan and I no longer possess the asset.
Lisa,
I’ll put you in touch with an attorney experienced with issues like yours who may be able to direct you in the right direction.
We kept out 1st home for our son. He couldn’t afford the expenses right now so we had to rent it out until he’s in a better financial position. The mortgage is rising and we can’t rent it for the amount needed nor can we afford to pay the difference our selves. Will this short sale low protect us?
Lisa - it depends on what you are able to negotiate with the lender and whether or not the forgiven debt would qualify. Not all lenders will forgive the debt.
I can no longer afford my home and need out but we owe what our home is worth! We’ve tried For sale buy owner, no luck! And we’ve been listed through a realtor for 6 months. Have had several showings but still no sale. And now my nieghbor has put there home on the market. And get this, their’s is 6000 thousand dollars less than ours. Their’s is a 4 bd ours a 3bdrm.Thinking about a short sale but can’t find out information on the laws in Kansas. Can someone help?
Stacey,
You need to speak with a lawyer and/or tax expert who is familiar with the law in Kansas.
I own a home in Northern California (primary residence- owned for +20 years) with equity and I also have liquid assets, the problem is I also own a home in Southern California (1 year 8 months), that is empty (un rented for 7 months now-and the value is $200k less than what I owe) This was a purchase money loan 80/20-never re-fi’d. I have NOT been 30 days late, yet. I can no longer pay the mortgage on the empty Southern, CA home, is it better for me to try and short sale or let it go into forclosure? How do I protect my equity in my primary residence and my liquid assets? Will I be 1099′D from the IRS? And when they say if your debt exceeds your assetts-you will no have to pay taxes on the forgiven amount, does that debt include my current debt owed on my primary residence?(I think it is called “insolvency”) Please help.
I have a quick question, I purchased my home inSacramento with a 1st and 2nd loan - 80/20 split. I refinanced the 2nd to make at least try and pay some P&I as my 1st is an interest only ARM (I have not refinanced my 1st mortgage loan). I am now having hardships and am going to miss my 1st monthly payments. Is there additional concerns I should have in regards to a short sale and the refinanced 2nd? Will it be tougher to get them to agree to a short sale or is there different tax issues with a refinanced 2nd?
Also, has the assembly/senate passed the California Forgiveness Acts into law yet? I assume at that point, with the Federal Act and the State Laws changed, people in California would have no tax ramifications for the following year as to income tax on thier short sales if primary residency? Is that a correct statement?
Please let me know…
Thinking of short sale but, afraid of the 1099 that comes after, the lender says I might qualify for “deed in leu of” if the home doesn’t sell in 90 days or ig they don’t except any offers form a buyer. They require a broker. Who pays the broker fees? The lender said they weren’t sure, every investor is different. I’m so confused. I tried for a loan modification & was denied because my income was int he negative, so how do they prevent & help you from going into foreclosure? Live in Florida
mill did you back request in broker property opinion before denied the modification? the bank will figureout how much they willing to loose that will inclued the Realtor commision but you really need to check in your area, for better information I lease that what i know in california.
I apologize for missing a few comments on this post.
LAM - Anytime there is debt that is forgiven or cancelled, the lender is required to issue a 1099. With purchase money loans, if the lender forecloses via a trustee sale, they can’t seek a deficiency. You should speak with a CPA or tax attorney about insolvency as a solution to the potential tax liability. I work with a real estate attorney who could advise you about your options - walking away, a deed in lieu, or acshort sale.
Joshua - if the 1st forecloses and the 2nd gets nothing, since the 2nd is not purchase money, they could opt to seek a deficiency. Same with a short sale. They can agree to let you sell the property, but may require you to sign a note. The key is negotiating a solution that eliminates any deficiency.
The bill in California seeks to mirror the Federal law with regard to tax liability associated with mortgage debt forgiveness.
Mil - the broker fees are paid out of escrow and are deducted from the proceeds the lender receives. With the deed in lieu, you need to make sure you don’t have a deficiency. I have an attorney in Florida if you are interested.
I owed the home for the first is 480,000 and the second is 61,000. and property tax is 6,500.
I stuck with the jumbo loan and make only minimum payment.
I purchased this property since 0ct 2004. since my husband out of work and was in Hospital and lost income for over 3 months, I can not afforted with any bill paying. we file chapter 7 on oct 2007 was discharge.
right now I was late payment for over 3 months, I had contact the bank ( loss minigation dept ) with my financial hardship, they let me make up my payment now. and I continued paying them up to now,
I have very difficult time to make this payment for the long run and my husban will be out of work in May 2009 again.
One of the realtor suggest me to do the short sale, they told me the new law has pass just for 2 week ago, to relief from any debt I owned from the bank and the property tax and IRS and I don’t have to pay them any fees, as soon as I sign the paper and let them deal with the bank.
I went on internet to find what was the new law has pass to save people for the short sale in california . but I can’t find any thing on the news for the short sale?
should I sign and let them deal with my bank? or I should contact my bank?
I don’t know what should I do now . Should I renting my house for someone and find a small place to leave :
Please help me .
Phoung, give me a call at 858-382-5820.
My fiance has a house that he and his former wife built over ten years ago. They were divorced in 2007, at which time he did a refi to pay off debt and pay her what was thought to be equity in the house. We are in SC. The value of the house is no where near what is owed on the house at this point. We have had the house on the market for 9 months. Three months into the house being listed the realtor gave him the advice to stop paying the mortgage payment and save that money to go toward a downpayment or lease for the next house, as his credit was already shot (around 500), and he was struggling to make the payments each month. Now, as I said the house has not sold, he lost his job in December of 2007, and has tried everything with Litton Loan Servicing to modify the loan, put payments at the end of the loan, or anything to save his house. Short sale was then entertained by the realtor, thus the house price being dropped $50K below what was owed on the house. He now has a foreclosure set for April 7. We did go to an “investor” who has agreed to try to help us and buy the house if he can get it through in the next two weeks, if Litton will accept the offer. My question is, like everyone else, If the amount owed on the house is $480,000, and the investor is able to buy the house via short sale for $350,000 or less, and requests the deficiency be waived, will we be looking at having to pay taxes on the difference that will be sent to us via form 1099C? This is his primary residence as it has been for over 10 years. There is a possibility that we will be able to lease the house back from the investor as well. We already understand the credit problems that will result in this, just are curious about this phantom tax issue.
I own 2 houses in the Temecula area. One of them has a balance of 500k and it’s value has dropped to the low 300’s.
My other house has no equity, it’s dead even (I live in this house). I can’t seem to rent out the 500k house for the price I need to break even. My only choice is to short sale or foreclose. I’m worried about losing my primary house. Does anyone have any suggestions on how t save my primary house? I can afford the payment on this house, just not on both properties. Is chapter 7 or 13 an option??
Kim, before you sign anything with an “investor”, PLEASE have an attorney advise you on the transaction and approve all documents. DO NOT EVER rely on an investor for advice. To often the “investor’ obtains title and the homeowner is still on the hook for the loan.
The new law only allows debt forgiveness on that debt which is equal to the original acquisition debt.
For example:
You owe $480,000
You sell it for $350,000
The cancelled debt is $130,000
Debt forgiveness would only apply to the amount of original purchase money debt that exceeds $350,000. if the the original loan amount was less that $350k, then none of the $130k debt forgiven would qualify.
Jerry - call me and I’ll put you in touch with someone who can explain your legal options.
Our daughter lost home to foreclosure in 2006 which does not hold benfits of the new law for 2007. They just got the new tax bill from IRS. They may be insolvent, live month to month. We tried to do a short sale, but Wilshire Lending refused offer because sellers would not agree to owe them debt of $50000. So we assumed that they would still owe the debt to Wilshire and waited to get the hammer. No word or 1099 until the IRS bill now. Must respond.
Is there any way to minimize this tax bill?
Your daughter needs to talk to a tax expert ASAP.
Minnesota home purchased in November 2007, can’t keep up. ? forclosure vs. deed in leu of forclosure. Home was worth 240 I paid 190, now worth 210. Do you know anyone in Minnesota I could talk with? Thank you!! Loree