If you are doing a short sale and you are wondering about the tax implications on the difference your house may sell for, then you should review this article about the mortgage forgiveness debt relief act and how it may impact you.
In 2007 the mortgage debt relief act was enacted to allow tax payers to exclude income from the discharge of debt in regards to their principal residence. Debt reduction through a mortgage restructuring and or in connection with a foreclosure may qualify for the relief.
The debt forgiven is only good for calendar years 2007-2012 up to a sum of $2 million of the forgiven debt. However, the exclusion does not apply if the discharge is due to services performed for the lender or any other reason not related to the decline in the home’s value and or the taxpayer’s financial situation.
What is cancellation of debt?
Here is an example to further explain: if you borrow $10,000.00 and default on the loan after paying back $2000.00, and the lender is unable to collect the remaining debt, there is a cancellation of debt of $8,000.00 which is generally taxable income to you.
Not all debt will follow under this exclusion, the most common situations where cancellation of debt is not taxable are:
– Bankruptcy: debt discharged through bankruptcy are not considered taxable income
– Insolvency: if you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
This is a general over view of this exception through the mortgage debt relief act of 2007. For further information you should go to: www.irs.gov