Hurry Up on Short Sale if You Don’t Want to be Slapped with Tax Next Year
Congress needs to act, or forgiven mortgage debt won’t be forgiven next year.
Palm Coast, FL – June 10, 2012 – Congress needs to act, or forgiven mortgage debt won’t be forgiven next year.
At the same time that a bright spot has emerged for struggling home owners trying to get a short sale closed – Fannie Mae and Freddie Mac now require shorter short sales from lenders they work with – there’s a looming cloud.
Unless Congress acts this year, short sale sellers will be in for an income tax increase in 2013.
Let’s say you owe $150,000 on your mortgage, but your REALTOR®; finds a buyer willing to pay $120,000. The bank approves the short sale and forgives the $30,000 difference. If you don’t complete the sale by Dec. 31, 2012, as of Jan. 1, 2013, that $30,000 in forgiven mortgage debt will be considered taxable income by the IRS.
It hardly seems fair, given that the reason the lender forgave the debt in the first place was to facilitate the short sale – and help an underwater home owner climb out of financial hardship. Now, those home owners will be responsible for paying a new tax on "phantom" income. And it’s not just debt forgiven in a short sale that would be affected: The same tax hike would apply to home owners who work with their lenders to restructure their mortgages if they’re granted debt relief.
Back in 2007, Congress passed a law designed to protect home owners from the tax, but that protection expires at the end of 2012. However, one Senate bill recently introduced by Sen. Debbie Stabenow (D-Mich.), – and two House bills – recently introduced by Reps. Charles Rangel (D-N.Y.) and Tom Reed (R-N.Y.) – seek to extend the law and eliminate the new tax. The Stabenow and Rangel bills would extend the expiring law for two years, and the Reed bill would extend it for one year.
"Mortgage debt forgiveness is not disposable cash for the mortgage holder," Reed said in a statement. "Piling additional burdens on people at such a difficult time makes their precarious situation worse."
"It’s bad enough that so many families are faced with mortgages that now exceed the value of their home," Stabenow said in a statement. "But to add insult to injury, without this bill, the IRS would once again require these families to pay hundreds or thousands of dollars in additional income tax when they sell or refinance their home. That’s just wrong."
There’s time yet for Congress to pass one of these bills – or better yet, make debt forgiveness relief permanent – but with so much uncertainty in the housing market, legislative action can’t come soon enough.
Do you think Congress will act in time, or do you think struggling home owners will get hit with a new tax?
Source: HouseLogic.com [June 8, 2012]
Tax forgiveness for investment property
The IRS Code provision you refer to pertains only to one’s primary residence. There are ways to avoid the 1099 when it comes to short sale or foreclosurebof second home and investment property as well. While most CPAs are familiar with the Form 982 insolvency exemption, there are other creative ways to avoid the inclusion of the 1099 income.
Taxed on short sale difference
Your article says protection from this kind of tax has been in place since 2007, but we sold our Palm Coast house in the "sailboat" section of the canals, in 2011, after aggressively marketing it for three years. It was a short sale, as the market value had dropped by 55% from the time we bought the home in 2005. This past April, we had to pay income tax on the difference between the short sale price and our mortgage balance. What we lost on the house, combined with this huge tax, has completely wiped us out. After 40 years of working, saving and investing, we have nothing. I had to take a correspondence course in medical transcription to start a NEW career (I’m 58). My husband, going on 60, has ZERO job prospects. I would like to know if the IRS was wrong to tax us on the difference? According to your article, there has been a law in place since 2007 blocking them from doing this. Please respond, as we need to know if we should contact the IRS for a refund.
Taxed on short sale difference
Your article says protection from this kind of tax has been in place since 2007, but we sold our Palm Coast house in the "sailboat" section of the canals, in 2011, after aggressively marketing it for three years. It was a short sale, as the market value had dropped by 55% from the time we bought the home in 2005. This past April, we had to pay income tax on the difference between the short sale price and our mortgage balance. What we lost on the house, combined with this huge tax, has completely wiped us out. After 40 years of working, saving and investing, we have nothing. I had to take a correspondence course in medical transcription to start a NEW career (I’m 58). My husband, going on 60, has ZERO job prospects. I would like to know if the IRS was wrong to tax us on the difference? According to your article, there has been a law in place since 2007 blocking them from doing this. Please respond, as we need to know if we should contact the IRS for a refund.
Reply to Sheila
First, I am neither an accountant nor a lawyer. I did speak with my CPA about your inquiry. Here is his abridged answer.
The law does exclude mortgage forgiveness under specific circumstances.
1. The home must have been your primary residence for at least two of the five years prior to the forgiveness. The years need not be contiguous.
2. An exclusion may also be available if you were insolvent (more debt than assets) at the time. You need not have filed for bankruptcy protection, just be insolvent.
Be sure to check with your own accountant if you think either of these situations might apply. If you were inappropriately taxed, you should be due a refund. The law has some complexities and alternative calculations that are best dealt with by a professional.