You may not have to pay taxes on canceled debt in a short sale. If you lost money on a foreclosure you can’t claim the loss on your tax return. Taxpayers who owe taxes due to a foreclosure may qualify to settle their tax debt for less than the full amount.
Some of those facts can be music to the ears of financially troubled homeowners confused about the tax burden associated with short sales, foreclosures and bankruptcies.
The latest relief effort for those facing mortgage problems comes from the U.S. Treasury Department’s Internal Revenue Service (IRS).
“Questions and Answers on Home Foreclosure and Debt Cancellation” offers salient answers to burning questions related to financial disasters at home.
The information is designed to reassure homeowners that while mortgage workouts can have tax consequences, special relief provisions can often reduce or eliminate the tax bite.
• Cancellation of Debt — In a short sale, often used as an alternative to foreclosure or bankruptcy, the lender forgives a certain portion of the amount owed on a home. The amount forgiven can be considered taxable income, but not always.
Debts discharged through bankruptcy are not taxable. For those who are insolvent when the debt is canceled, some or all of the canceled debt may escape taxation. If you really lose the farm, certain farm-related canceled debts are not taxable. Also not taxable is the forgiveness of dept on so-called non-recourse loans, loans for which the lender’s only remedy in the case of default is to repossess the property.
• Foreclosures — In a foreclosure, if there is any cancellation of debt (other than on non-recourse loans) or a gain from the foreclosure (because a foreclosure is treated as a sale) the amounts could be taxable unless you meet one of the exemptions for cancellation of debt mentioned above.
Also, some or all of the gain from a foreclosure sale of a personal residence qualifies for exclusion from income under the U.S. Taxpayer’s Relief Act of 1977.
If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income.
The new IRS section includes a host of additional information, including worksheets to figure cancellation of debt income and gain from foreclosure as well as links to related publications, fact sheets and tax filing forms.
It behooves anyone facing these complex issues to seek professional tax help to determine how these tax rules do or do not apply.