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By now, chances are you have probably heard the term “short sale” – especially during the past five years with our housing market struggling to recover from the housing market crisis of 2007. Luckily, we have enjoyed a strong economy and have not seen too much of the same dire circumstances many homeowners across America have experienced. Still, if you owe more on the house than what it is worth and are looking to sell it, a short sale is likely your best option.
Everyone has a pretty good idea of how a short sale might impact one’s credit outlook. Though it may not have as heavy an impact on credit as a foreclosure might, a couple years after a short sale before the homeowner can consider buying a home again. There is, however, a tax implication of doing a short sale that many people are not aware of. The amount of debt that a bank agrees to forgive in order to allow a short sale to take place is forgiven debt and the IRS considers that amount as income. As such, all income is taxable, leaving the homeowner that opts for a short sale with a significant tax bill at the end of the year.
Mortgage Forgiveness Debt Relief Act
In light of our nation’s struggles with property ownership after housing values plummeted, the Mortgage Forgiveness Debt Relief Act was signed into action, allowing homeowners an exemption on discharged or forgiven debt from the sale of a primary residence.
This benefit has been around for some time now and has been extended by the government in the past, however its deadline is fast approaching with a program end date of December 31, 2012. This means that all homeowners considering short sales should complete their transaction before the end of the year.
Short Sale Process Can Take Months
At first, when countless Americans struggling with the economy and declining values, short sales were slowly began picking up pace. Then, when the 2010 robo-signing scandal broke loose, banks again lacked confidence in doling out relief in this form to borrowers, ending up in short sale processes that could take up to a year or even more.
Today, however, many banks have streamlined the process and even prefer the short sale route versus a foreclosure. Compared to the lengthy process times and extensive legal fees involved in a foreclosure, banks are even willing to pay out cash in some short sale cases.
Window Of Opportunity Will Not Last Long
Since the halfway mark of the year has passed, we strongly advise any homeowner looking to sell their home despite owing more than its current value, to contact us today. Timing is key and with just a few months before the end of the year to take advantage of this benefit, now is the good time to start the process.
Ten Facts the IRS Wants You to Know About the Mortgage Debt Relief Act
1. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.
2. The limit is $1 million for a married person filing a separate return.
3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.
4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.
5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.
6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.
7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.
8. Debt forgiven on second homes, rental property, business property, credit cards or car loans do not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.
9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.