The Importance of your Short Sale Closing in 2012
Time is running out for homeowners who want to short sale their home and avoid paying income taxes on the debt forgiveness.
That’s because the Mortgage Tax Debt Forgiveness Relief Act, which excludes most sellers from having to pay income taxes on the debt forgiveness associated with a short sale, loan modification or foreclosure, expires at the end of 2012.
A short sale, foreclosure or a loan modification that involves principal reduction, is debt forgiveness, which is considered to be ordinary taxable income by the IRS and CA Franchise Tax Board. Therefore, when any of the above occurs, the lender will issue the seller a 1099C for whatever amount was forgiven. Normally, the seller has to pay federal and state income taxes on that forgiven debt.
However, the Mortgage Tax Debt Forgiveness Act of 2007 (and a companion law at the CA state level) excludes most sellers from having to pay taxes on that 1099C, assuming the debt is purchase money or was used to improve the property (cash out refinance money that was not used to improve the property is still taxable).
While there has been talk about extending this bill, and even a bill proposed by the Senate Finance Committee this summer, a 2 year extension would cost the federal government an estimated $2.7 billion in revenue, and there are concerns that Tea Party freshmen in the House will likely oppose the debt-relief extension because they see it as another costly bailout funded by taxpayers.
Bottom line, there is too much uncertainty to depend on our elected officials approving an extension. Upside down homeowners who want to get out from under their homes without incurring a tax liability need to make sure they close before the end of the year.