Posted by David Leibowitz on February 10th, 2011 in Bankruptcy and Taxes
Banks frequently will send you – and the Internal Revenue Service – a form 1099C after you have completed a short sale of real estate. What does this mean? Well, if you owed the bank $250,000 and sold the house for $200,000 payable to the bank, there could be income tax consequences? Why?
Forgiveness of indebtedness is generally considered to be income. In other words, if you paid $200,000 to settle a $250,000 loan, you are considered to have received income in the amount of $50,000. As a matter of fact, this is “ordinary income” which can be taxed at rates approaching 40% when taking into account state income taxes.
But if you had to have a short sale, it’s probably because you were in financial difficulty in the first place. So if you file a bankruptcy after a short sale leading to “forgiveness of indebtedness income” or if you are insolvent – meaning less assets than liabilities – you may not be required to pay income taxes even if the bank stuck you with a IRS form 1099C. The IRS has issued a very good explanation of the entire situation here. The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
So if you succeed at a short sale, you have a very good chance of avoiding income taxes in respect to cancellation of debt. When in doubt, contact us at Lakelaw, Your Financial Lifesaver ™.