Exceptions to Paying Taxes After a Short Sale

By MyVine | June 7, 2011

Homeowners who sell their homes by means of a short sale are frequently really concerned with the tax implications of the sale. The bank, by forgiving a portion of the debt, will then be responsible for reporting the forgiven quantity to the IRS as income to the borrowers. At tax time, the former homeowners are responsible for including this quantity within their gross income and then paying taxes on it.

Thus, there’s a powerful possibility that homeowners who sell their household for less than what they owe on it’ll need to pay thousands of dollars out of pocket in order to cover the tax bill on the short sale. They thought they had been losing the home but avoiding having to make an high-priced payment to the lender. In the end, though, they lose the household and still need to make a huge payment to the IRS.

Homeowners, though, might be able to prevent this scenario when they get into a couple of exemptions, or the quantity of debt forgiven is classified a certain way.

For instance, if the borrowers are insolvent before the discharge of the debt. The amount that can be excluded from other income is that amount up to the extent of their insolvency. For example, if the borrowers have $10,000 in assets and $18,000 in liabilities, they are insolvent by $8,000. Debt is often forgiven up to $8,000 just before they would need to report it as income to the IRS. But any quantity over $8,000 forgiven would have to be reported and taxes would have to be paid on.

There is also an exemption for debts that are discharged through the bankruptcy process. There’s no limit to this exemption from income, as homeowners can exclude an unlimited amount of discharged debt if it has gone through bankruptcy. The only stipulations are that the borrowers be under the supervision of the bankruptcy court, along with the court grants the discharge of the debt.

Foreclosed homeowners may well also have the ability to have the debt forgiven as interest as well as other fees, which do not count as income. Only forgiven principal could be regarded as forgiven debt, so if the borrowers and bank agree that the amount not collected as a result of the short sale consists mostly of fees and interest, there could be no income because of the sale of the property. This exclusion, nonetheless, may well be affected if the borrowers took a tax deduction for interest in prior years.

You’ll find quite a few tax problems that homeowners should be aware of when they are taking into consideration regardless of whether or not to go through with a short sale. While they may possibly wind up with a 1099-C form at the end of the year showing a big amount of forgiven debt, this does not mean that they have to pay taxes on all of that income, depending on their financial scenario.

Despite some tax issues, a short sale still remains a viable answer to foreclosure. The fact is, the government has even loosened a few of the rules on income due to short sales, also as supplying other incentives for lenders to take into account alternatives to foreclosing on a property. With much more foreclosures will come far more attempts to help borrowers lessen the financial burdens that come with owning or losing a residence.

Topics: Buying Tips, Financing, Foreclosures, General, Investing, Selling Tips | Comments Off

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