It’s no secret that many people are trying to get out from under the gun of foreclosure in the recent market. One way to avoid the smirch of foreclosure on your financial record is to consider doing a short sale – that is, selling the house before the bank takes it in foreclosure. Typically when this happens the bank takes any profits made from the sale of the home and forgives the rest of the debt.
However, this can be problematic for former homeowners who now have no home – the IRS usually considers any sort of forgiven loan a form of income, and taxes it. This means that if a homeowner bought a house for 300,000 and then saw it devalue to 260,000, there’s a 40,000 dollar difference. If the house is being foreclosed on, the homeowner can sell the house and give the bank the 260,000, but even in the event that the bank decides to forgive the 40K in lost property value, the IRS will tax that 40K as phantom income!
While this might sound frightening (and to a certain degree it is), the good news is that currently the IRS and the banks are working together, if not by choice. That is, in the above example the bank would be compelled to forgive the former homeowner the 40K, and the IRS would not consider that forgiven loan as income.
Sound too good to be true? It’s not, but the window of time isn’t infinite – the deal only stands until January 1, 2013. So if you’re looking to get that house out from under you before foreclosure hits, now would be the time.