Group of house icons with a sign sold on one of them

Group of house icons with a sign sold on one of them

Homeowners who sell their home through a short sale, get their principal balance reduced, or lose their home to a foreclosure may face tax consequences due to the cancellation of debt. However, there are ways to minimize, reduce, or avoid the tax consequences if you fall under certain categories.

Basically, if you took out a mortgage for $200,000 and now the house is worth $150,000 and you short sell the property, the IRS considers this $50,000 that the bank forgave as taxable income. You promised to pay $200,000 when you took out the loan, but you only paid $150,000 so therefore, you basically cancelled this debt and this is construed by the IRS as taxable income that you are required to report and pay taxes on.

Homeowners do not despair! In 2007 Congress enacted the Mortgage Debt Relief Act, which allows homeowners to exclude income from the cancellation of debt on their principal residence. Originally, Congress authorized the act to apply to all affected homeowners who short sold, foreclosed, or modified their loans between 2007 and 2012, and the act was set to expire on December 31, 2012. However, Congress reauthorized the Act for one more year, and homeowners who undergo a short sale or loan mod their homes in 2013 will also be able to take advantage of the Tax Act. Furthermore, Congress is already looking into extending this bill for another two more years.

Are you worried about not short selling your home in time before the act expires? Well there are other tax provisions, such as insolvency. Basically you are insolvent if at the time of your short sale, principal reduction, or foreclosure if you owe more in debt than what you have in assets. So let’s say you owe $300,000 on your mortgage; however you short sell the property for $200,000, which means you are under water by about $100,000. If you do not have $100,000 in assets (including retirement accounts) at the time the sale goes through, then you are insolvent and not liable for the tax consequences. You are insolvent and you can short sale at any time even after December 31, 2013 so long as at the time of the short sale you are still insolvent.

An example of this is Bob owes $300,000 on his mortgage, but his house is short sold for $200,000 in December 2014. In December 2014, Bob owes $60,000 in student loans, and also has another $ 30,000 in credit card debt along with the $100,000 in underwater mortgage debt. Bob only has $15,000 in his retirement accounts and $10,000 in his bank account. In this example, Bob is insolvent as his debts are greater than his assets and therefore he does not have to worry about paying taxes on the $100,000 mortgage debt that he short sold. He can take his time to short sale his home. If you are unsure of whether or not you qualify, feel free to give us a call, everyone’s situation is different.

It is almost always a better idea to short sell your home now, so that you can get a fresh start with your life. Therefore now is the best time to act if you have been thinking of short selling your home. We can not only help you short sell your home, but we can also help you with the tax forms to take advantage of the Mortgage Debt Relief Act, and avoid paying taxes on the cancelled debts from the short sale of your home. And remember, the Act is only good until December 31, 2013, unless it gets extended, so don’t delay if you are thinking about short selling your home.


Van and Associates Law Firm has helped many in the Las Vegas and Henderson community with foreclosure, short sale, bankruptcy, debt settlement, loan modification, government homeowner programs, and personal injury.

Please feel free to contact us today so that we may discuss the options that are available to you.
Van and Associates Law Firm at 702-529-1011