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Are Taxes an Issue After a Short Sale?

Are Taxes an Issue After a Short Sale?

A New Jersey short sale is a great way for local families with trouble paying their mortgage to get back on financial track without going through the stressful, costly, and credit- damaging foreclosure process. Yet, it is important to be fully informed of all facets of a short sale–it is not necessarily as simple as selling your house to another and having your loan forgiven. For one thing, tax consequences must be considered.

Tax Implications of Short Sale

Short sales are beneficial to a homeowner because they result in a portion of a debt being forgiven–the difference between the sale price and the amount remaining on the loan. This cancellation of debt has income has tax consequences. In general, the amount of debt cancelled must be reported as income on the year’s tax return. A lender must provide a 1099-C form that lists exactly how much debt was cancelled as part of the arrangement.

Reporting the cancelled debt as income means that your income tax burden for that year will be larger. Considering that the short sale was likely pursued because of financial difficulties, this may come as an unpleasant surprise to those not prepared for it. For example, if a home sells $50,000 short of what is owed on the mortgage, the selling homeowner could be liable for $12,500 (if in the 25% tax bracket) or $7,500 (if in the 15% tax bracket). These are not small sums.

Special Rules to Avoid Income Tax Following Short Sale

Fortunately, the federal government recognizes that many individuals pursuing a short sale are unable to meet the resulting tax burden. To help struggling homeowners, the federal government passed laws to eliminate the income tax consequences for short sellers in some cases. As a result, homeowners can exclude income from the discharge of debt on a principal residence. This benefit also applies to debt incurred via a home equity line of credit if used to improve the residence.

In addition, New Jersey laws generally align with federal law on mortgage debt relief income. This means that borrowers may be exempt from both federal and state income taxes on forgiven mortgage debt.

But this benefit will not last indefinitely.

In fact, the federal act which created this benefit–The Mortgage Forgiveness Debt Relief Act–is set to expire at the end of this year. The legislation may be extended by Congress, but most observers understand that the current federal gridlock makes that extension unlikely. In other words, time is of the essence when it comes to short sales this year.

Legal Real Estate Help in Lawyer

Tax law is confusing and complex, particularly in unique real estate transactions like short sales. Understanding the implications is one of many reasons why it is vital to have professional help when figuring out if a short sale is right for you. If you are in Burlington County or elsewhere in New Jersey, the Moorestown short sale attorney at our firm is available to aid homeowners. In many instances, a lender will pay for all attorney fees, and so there is little to lose by visiting with a professional to learn more.