4 Easy Ways To Avoid Taxes On Short Sales And Foreclosures If you give up your home in a short sale or foreclosure, you may need to pay taxes on the forgiven debt. Here are 4 ways to avoid that problem. Federal law created an exception for a standing IRS rule that treats debt that is forgiven as if it were real money that you received. That “money” was income, subject to tax. A powerful exception to that rule was born in 2007 when the nation first began to struggle with increased foreclosures. Under that newly enacted exception, debt associated with a principal residence that was lost to foreclosure or short sale was excluded from income. In other words, if you lost your home then you wouldnt be penalized by the tax man. Expiration Of The Tax Exemption The Mortgage Debt Relief Act of 2007, as the exemption was formally known, expired on January 1, 2014. If your home was foreclosed or sold short in 2013, you still get the benefit of the mortgage debt exception when you file your return in 2014. If the house is lost at any time after December 31, 2013 then you can’t claim the benefit of the federal law (though California homeowners still have the same protections). Avoid The Tax In One Of 4 Ways Though there’s no longer a home-specific safe harbor from taxes generated by cancellation of debt , there are longstanding exceptions to paying tax on cancelled debt. These surviving exceptions apply whether the debt is forgiven in a short sale, a foreclosure, or a debt settlement arrangement. Insolvency: Forgiven debt is not counted as income if your remaining debts are greater than the value of your assets when the forgiveness occurs. The catch is that the IRS includes in your assets your retirement savings, which are usually excluded from the solvency calculation elsewhere.Here’s the insolvency worksheet from the IRS Publication 4581, explaining cancellation of debt and taxes.If you had debt forgiven, you probably got a 1099 form from the lender or its agent. That form simply reports to the IRS the facts of the transaction, as known to the creditor. Discharge The Debt In Bankruptcy: Debt that is discharged in a bankruptcy case doesnt create a tax liability. So long as the bankruptcy is filed before you part with your home, for tax purposes, there is no debt existing when a sale occurs later. No Liability = No Tax. If there is no personal liability for a debt, there is no debt to be cancelled by foreclosure. The debt is gone, and therefore foreclosure sale doesnt change your balance sheet with respect to the debt. Non-Recourse = No Tax. If a debt is “non recourse”, then the lender can only sell the collateral to collect the debt. If neither the insolvency exception nor the bankruptcy exception apply to you, ask your tax professional if the cancelled debt was recourse or non recourse. We can hope and lobby for an extension of the Mortgage Forgiveness Debt Relief Act for property sales that happen this year. Meanwhile, check your state tax law for its approach to short sales. If you have questions please call me 917-470-1053
Posted on: Thu, 06 Mar 2014 00:04:27 +0000
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