Short Sales - Tax Liability Forgiveable Debt
Tax Liability on Forgiveable Debt
There is always one thing that never changes, death and taxes. Unfortunately our incredibly fair goverment (sarcasm), considers forgiveable debt as earned income. For you this means that any debt that is forgiven by your debtor, the IRS says you owe taxes on that amount as if that was income recieved for that year. So if you either complete a short sale, deed-in-lieu or a judicial foreclosure, whatever the loss to your lienholder, you may owe taxes on that amount.
Hold on, there are some options to consider.
Can I Get the Tax Liability Waived on Forgiveable Debt
There are options where some property owners can get full tax liablity waived on forgivable debt. It is important to point out I am not an attorney or a CPA and this is not tax advice. You will need to consult with the appropriate professioanl to find out if you are able to get a tax liability waiver.
When talking to your CPA, attorney or professional handeling your taxes, let them know you are considering a short sale and would like to know the implications of the tax liability for forgiveable debt. You could also mention the "Mortgage Forgiveness Debt Relief Act" which to date has been extended to 2025. There are number of factors which could determine if you would qualify for the exclusion of debt from income claims on your taxes. Some of thise may include if the property is primary residence, under a cap of forgiveable debt, whether the debt was used to improve the property or used for purposes outside of that.
Even if you don't qualify for the "Mortgage Forgiveness Debt Relief Act", like in the case where the property is not a primary residence, there are other options that may allow you to get this liability waived such as if you are insolvent. Only your tax professional can answer that since they are the ones who have access to your financials.
How Tax Liability Differs in a Short Sale vs Foreclosure
On the surface there is really not much of a difference in terms of tax liablity. However, I a short sale present and opportunity to control the liablity. If you qualify for the tax liability waiver, it is really not a concern. The main concern is if you don't and for those of you that foreclosure maybe inevitable, a short sale will allow you to mitigate and decrease the amount of that tax liablity. In a judicial foreclosure, the costs, length of holding time and any potential damage incurred during the lienholder can increase the tax liability due to an increased loss at the foreclosure sale.
