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TwitterTraditionally, when a homeowner completes a short sale, the mortgage lender will file a loss on their principal investment, which results in a gain on the homeowner. This is called Cancellation of Debt by the IRS. This means at the end of the year, the lender will mail out a 1099 to the homeowner who completed a short sale. As you can imagine, the effect on the homeowner would be devastating, because they never actually receive this “income” (or some call it phantom income).
Our government recognizes this and understands how much impact there is to millions of homeowners in the recent real estate crash and devised a bill to waive this off for primary residence home. The congress bill is called HR.3648 – Mortgage Forgiveness Debt Relief Act of 2007. This bill removes the Cancellation of Debt up to $2M for a primary home. Later there had been an extension of this bill HR.1424 – Emergency Economic Stabilization Act of 2008 that extends the deficiency tax waiver to December 31, 2012. The idea is while your lender may file a 1099 on the cancellation of debt income, your tax filing person can help fill out a IRS form 982 to waive off this tax. As the end of 2012 approaching, there are talks about extensions but not guaranteed. Right now is still the best time to do a short sale and take advantage of this tax waiver provided by the government.
On IRS website, it has clear explanation on what qualifies for this tax waiver:
http://www.irs.gov/individuals/article/0,,id=179414,00.html
Click here for the link of the key summary of HR.3648 and HR.1424.
Here is the IRS Publication 4681 on Canceled Debt and Foreclosure.
Lastly, our tax advisers explain that the California tax laws mirror the federal tax laws, so there are similar protections on California tax to homeowners as well.
Investment Properties and Refinanced Properties
Many short sales completed are either investment properties from condos, single family homes, to 2-4 unit multi-family homes, or 5+ multi-family homes and any commercial property. Many other short sales completed are homes that were bought long time ago but there had been large cash out refinanced amount taken out that may not completely qualify for the tax waiver. According to our tax advisers, there may still be exceptions made to waive off the Cancellation of Debt. The concept is Insolvency. Being insolvent means one’s Liabilities are more than one’s Assets. There are IRS forms that allow a property owner to file insolvency. For more information on this, consult your tax advisers for more details.
Lastly, many investment properties, commercial properties were purchased near the peak of the market and finally sold as short sale for much less than the original purchase amount. Then, the traditional Capital Loss deduction works here without any special tax waiver laws. Typically, the capital loss amount should be enough to compensate for the Cancellation of Debt from the result of the short sale. For more information on this, consult your tax advisers for more details.
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The above information was gathered by our research and work experience as real estate agents working on distressed properties. Please note we are not attorneys or accountants and we do not provide legal or tax advises. Please consult your own attorney and accountant for legal and tax advises.
