It is very important for a Homeowner considering a Short Sale and who might be eligible for relief from the income tax consequences of the Short Sale to initiate the process as soon as possible in order to close escrow prior to December 31, 2012, at which time the Mortgage Forgiveness Debt Relief Act of 2007 will expire.
A Short Sale or Foreclosure can have adverse income tax consequences under certain circumstances. Where debt has been forgiven (i.e. cancelled) as a result of an approved Short Sale the lender will send the Homeowner a Form 1099 C stating the amount of debt that has been cancelled. To avoid taxation of cancelled debt the taxpayer must be eligible for an exemption. The primary available exemption is under the Mortgage Forgiveness Debt Relief Act of 2007. To qualify for this exemption the loan in question must be a Qualified Principal Residence Indebtedness which is defined as a loan used to buy, build or substantially improve a principal residence and be secured by that residence. Refinanced debt proceeds used for the purpose of substantially improving a principal residence also qualify for the exclusion. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt do not qualify for the exclusion. Additional details regarding the law are available on the IRS website.
IMPORTANT DISCLAIMER: Homeowners should always consult directly with their own tax adviser regarding any and all tax consequences of any real estate transaction. There are other exclusions available relating to Insolvency and Bankruptcy