Property Solutions of Florida

In general, how the Internal Revenue Service treats a short sale of a property depends on how the property was used.  Please keep in mind, your personal finances can have an influence on how the Internal Revenue Service treats a short sale.  However, in general the treatment could fall into two categories:

Sale of Principal Residence: 
The Mortgage Forgiveness Debt Relief Act of 2007 (click here to view the IRS guidelines) allows homeowners to exclude income realized from the forgiveness of debt on their principal residence.  Prior to this act, taxpayers would be required to report the forgiven debt as income on their tax return.  With this Act, mortgage debt forgiven in connection with a short sale qualifies for this relief.

A summary of the rules and qualifications are as follows:

• The debt must have been forgiven by the lender in 2007, 2008, 2009, 2010, 2011 or 2012;
• The amount of eligible debt excluded from taxation is limited to $2MM for married couples, $1MM if married and filing separate tax returns;
• The exclusion can only be used if the loan was taken out to acquire, build or substantially improve a principal residence; and,
• The property must qualify as a principal residence as defined in the qualifications used to determine eligibility under Internal Revenue Code 121.  Simply put, in the five years prior to the debt being forgiven, the owner must have lived in the property as a principal residence for an aggregate of two years.

Again, this is a summary.  There are exceptions and additional criteria that may come in to play depending upon your personal situation.  Should you have any questions regarding how the legal or tax consequences will affect your personal situation, we recommend that you consult with an attorney or tax/financial advisor that is familiar with your personal details.

Sale of Investment Property/Non-Principal Residence:
Unfortunately, these types of properties do not qualify under the Mortgage Forgiveness Debt Relief Act of 2007.  After the short sale is completed, the borrower may be liable for federal income taxes on the amount of the debt forgiven and receive a 1099-C from the lender. 

Usually, the borrower has two options in dealing with this additional tax liability: 1) Negotiate a payment plan or settlement for the taxes due on the debt forgiven; or, 2) Offset the "additional income" reported from the debt forgiven with any loss reported on the short sale of the non-qualifying property, for example. 

As these answers are intended to give direction and not specific legal or tax advice, we recommend that you consult with an attorney or tax/financial advisor that is familiar with your personal details should you have any questions regarding how the legal or tax consequences will affect your personal situation.