Throughout the past two years, the words "foreclosure" and "short sale" have become a part of a Real Estate professional's daily vocabulary and unfortunately, it's looking like that isn't going to change anytime soon. A Homeowner who is considering doing a short sale (a short sale occurs when a home is sold for less than what is owed on the Seller's mortgage and the bank agrees to accept this arrangement) naturally is and should be concerned about the resulting tax liability.
Traditionally, The IRS views any type of debt forgiveness as income and as we all know, taxes are levied on income. How it works, is say a homeowner has a mortgage in the amount of $250,000 but his/her home is now only worth $190,000. The homeowner contracts a Real Estate professional to sell his/her home and the Seller finally accepts an offer of $190,000. The Sellers bank does its own appraisal of the property and determines that indeed the offer of $190,000 does reflect the current market value. Once the bank agrees to accept this loss, the transaction can then move on to settlement. Tax time rolls around and the homeowner who sold his/her home as a short sale now realizes that he/she is expected to pay taxes on "income" (the difference between the $250,000 owed and the $190,000 accepted) that he/she never received.
The good news is that the "Emergency Economic Stabilization Act of 2008" has now extended a previously passed exclusion to the IRS laws that would basically exclude a homeowner in a short sale situation from paying taxes on forgiven debt "income" on his/her principal residence. This exclusion now applies to debt discharged after 2006 and before 2013. For more information on this provision, please visit irs.gov and as always, talk to your accountant for the most updated and accurate information as everyone's tax situation is different.
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