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Disclaimer: I am not an accountant or an attorney. It is important to consult with a professional tax attorney or accountant when considering the implications of the law regarding your individual situation.
In order to avoid home foreclosures, which can be complicated and lengthy, banks often engage in negotiations with borrowers. A short sale occurs when the mortgage lender (the “mortgagee”) agrees to alter the original terms of the loan by lowering the outstanding balance of the debt. Such forgiveness often takes place in cases of a financial deficiency, or when shifts in the real estate market result in a negative net equity on the part of the borrower (the “mortgagor”). In particular, under a short sale the home owner is allowed to sell their home for less than their outstanding debt and give the proceeds to the lender in return for forgiveness of the loan.
If you are considering a short sale there are a number of tax implications to factor into your decision. When the lender and the borrower are able to reach a short sale agreement, the forgiven portion of the loan may still be taxed as income on the part of the borrower. This article aims to provide guidance on the most recent changes in the IRS tax structure as it affects short sales.
In general, the IRS tax code specifies that a borrower must file a 1099C Cancellation of Debt form when the forgiven amount equals or exceeds $600. Traditionally, the IRS has treated this amount as fully taxable income on the part of the borrower. The 2007 Mortgage Forgiveness Debt Relief Act (Public Law 110-142, HR 3648), however, amended the tax laws to allow borrowers negotiating the loan on their primary residence to avoid having to declare this debt as income (limited to debts of $2 million or less.) Importantly, this forgiveness stipulation does not apply to rental properties or other non-primary residences that a lender may hold. Previously, only a personal bankruptcy filing could prevent the forgiven debt from being treated as taxable income. The Debt Relief Act effectively provides an amendment to the original 1986 Internal Revenue Code which allows selective exclusion of forgiven debt from taxable gross income.
Under the conditions of Form 1099-C, there are special circumstances that may affect whether canceled debt is treated as taxable income. In cases where the borrower declares bankruptcy, the debts are fully discharged although the declaration may have broader adverse effects in terms of other financial and tax obligations.
Additionally, under certain circumstances the debt is not taxable if a professional accountant has determined that the value of the debt is greater than the appraised, fair market value of the asset in question. Farm debt is also treated differently according to the law, which is signified by direct farm debt for those who earn over half their gross income directly from farming. If you are seeking to execute a short sale on a residence other than your primary home, but which served as a secondary residence for you personally during the last five years, the Relief Act also provides a graduated scale of gross income reductions. Depending on the time you physically lived in the home in question, you may be able to deduct a portion of the forgiven amount. It is important to consult with a professional tax attorney or accountant, however, when considering the implications of the law upon your individual situation.
10.2 Capital Gains, Losses/Sale of Home: Stocks (Options, Splits, Traders)
Should I advise the IRS why amounts reported on Form 1099-B do not agree with my Schedule D for proceeds from short sales of stock not closed by the end of year?
If you are able to defer the reporting of gain or loss until the year the short sale closes, there are certain notations you can make on Form 1040, Schedule D. Capital Gains and Losses that will allow you to reconcile your Form 1099-B to your Form 1040, Schedule D and still not recognize the gain or loss from the short sale. Always remember to include your name as it appears on the tax return and your accurate social security number. This is the number one reported filing error!
Research Links:
http://www.irs.gov/newsroom/article/0,,id=174034,00.html
http://www.irs.gov/faqs/faq-kw171.html
