Selling your home via short sale is still an attractive option for some homeowners facing underwater mortgages and looking for a way out. A recent study showed that the average short sale results in $60,000 in debt forgiveness; for the struggling homeowner, that forgiven debt can be a godsend. There are more than a few intricacies to the short sale process.
Tax Forgiveness Limited
The IRS passed a law in 2007 prohibiting the treatment of debt forgiven in short sale as taxable income, but that law is very specific, and it’s important to understand its limitations to avoid misrepresentation. For example, it does not apply to the short sale of a second home, nor does it apply to certain kinds of refinancing; these would be taxable under the law as income. If this is confusing, perhaps it is because people don’t typically think of loan forgiveness as income, says the foreclosure attorney. But in the eyes of the IRS, if a lender forgives $60,000 in debt, that is the same thing as if you gained $60,000 in income – on the balance sheet, it looks the same, so to the IRS it looks the same. Prior to 2007, that $60,000 would be taxable income just like the income from your job or anything else. The IRS passed the short sale forgiveness law to help homeowners struggling under the crushing weight of the housing market crash; facing the additional tax burden of paying taxes on the $60,000 they never really had in the first place would have proven devastating to too many underwater homeowners.
This law is still currently in effect, though it will be sunsetted this year; still, even with the law in effect, it does not apply in 100% of all short sale situations, and he advises hiring an expert to help with your short sale.