Short Sale Tax Consequences Looming in San Diego?

Short Sale Tax deadline may affect San Diego County Residents.

Carlsbad-Short-SaleSuffice to say, most people are unaware of the potential tax consequences of a short sale (or foreclosure for that matter). A short sale involves selling a property for less than the amount owed to the lender. Per the tax code, the IRS considers a short sale a “Debt Cancellation”. When a lender cancels or forgives debt, the difference between what was owed and the amount the lender received to cancel or forgive the debt may be taxable to the borrower. For example, assume you owe $550,000 on a mortgage and subsequently sell the property via a short sale for $450,000 and receive forgiveness for the $100,000 difference — this amount could be taxable income.

Loan modifications – changing the terms of a loan — that result in a reduction in the loan balance may also be taxable. Effectively, a reduction in the balance of the loan may be taxable as forgiven indebtedness. Foreclosures may also result in reportable income to the homeowner that walked away.

Fortunately, the Mortgage Debt Relief Act of 2007 allows many homeowners to exclude the forgiven debt on their tax returns. Several conditions must be met for the forgiven debt to be excluded from income for tax reporting purposes. First, the indebtedness must have applied to a qualified principal residence. Second, the indebtedness must have been secured by the residence. The amount excluded from income is limited to $2 million for married taxpayers or $1 million for single taxpayers. Finally and perhaps most important, the debt must be forgiven in calendar years 2007 through 2012.

For homeowners considering a San Diego, La Jolla, or Carlsbad Short Sale,  the tax consequences may be significant. As an example, if the amount of forgiven debt is $100,000, there may be no tax consequences if the closing occurs this year (2012). If it closes in 2013, the $100,000 may be taxable and depending on the tax rate of the San Diego, La Jolla, or Carlsbad Short Sale homeowner – resulting in tens of thousands of dollars in taxes due.

Of course there are forms to be filed and additional rules to be considered. For more details you can visit IRS website. The site includes links to the required forms as well as complete information on what debts qualify. It goes without saying that each person’s circumstances vary and consulting with your tax professional is advised. If you have questions about the short sale process or are considering a short sale or a loan modification, contact our office.

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