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Understanding Short Sale Taxes

Sunday, February 5th, 2012

When many individuals are losing their homes due to their lack of ability to pay their mortgage liabilities, owners are continually looking for ways to decrease their losses thru various means. One of these is doing short sales.

What’s short sale?

A short sale takes place when the mortgages against a property are greater than the property’s selling price. Many house owners resort to short selling to avoid foreclosure on their homes and at the same time still be able to pay off the loan to the lender through settlements.

The amount of debt that is canceled by the bank may become part of the borrower’s taxable earnings.

Nevertheless, not all canceled financial obligations will end up in taxable revenue. The exceptions include bankruptcy, insolvency (when total debt exceeds the fair market valuation of the taxpayer’s total assets), and certain farm debts (those at once sustained to operate a farm where over fifty percent the earning from the previous three years was from farming and the indebtedness was to an individual or an agency engaged in lending). Additionally, non-recourse loans and qualified principal residence indebtedness under the Mortgage Debt Relief Act of 2007 are also part of the exceptions.

Mortgage Debt Relief Act of 2007

In general, if you owe someone debt on your property and the bank forgives or cancels your debt, you may be taxed on the amount of loan pardoned.

Nevertheless through The Mortgage Debt Relief Act of 2007, taxpayers are able to exclude revenue gained from the discharge of debt on primary residence. The Act applies to all debts forgiven in the calendar years 2007 till 2012. The qualified amount for exclusion is up to $2 million of the forgiven debt and up to $1 million if the taxpayers are married but filing separately.

The exclusions are subject to some conditions. Before anything more, the cancelled debt should have been used to buy, build, or improve the principal residence. The exclusions do not apply if the discharge of the debt is due to the taxpayer’s performance of services for the bank or any other cause not directly related to the drop in the value of the principal residence or a fall in the financial condition of the taxpayer.

In the past, the IRS used to treat the pardon of debt as a taxable earnings. But taking out a mortgage is a financial obligation because you have to pay it back. When the loan indebtedness is removed or when it is reduced, such as when the bank forgives the loan, then the total amount of the returns become reportable as revenue since the duty to repay no longer exists. For the cancellation of debt, the lender should report the total amount of the cancelled debt to the borrower and the IRS on a Form 1099-C, Cancellation of Debt. Qualified householders must complete IRS form 982, which must be passed together with the Fed taxation assessment for the mortgage relief to be claimed.

Every short sale deal is never be the same. If you’re planning to explore this avenue, you have to have a clear knowledge of everything involved in short sales, especially the short sale tax consequences, if any.

Kendra Chui a in California helps householders to .

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