Many people wonder what tax consequences may be ahead should they go into foreclosure, get a loan modification or sell their home by short sale. This is a question for a CPA or tax attorney, not a real estate person. Every situation is different and requires analysis and advisement from an expert.
That said, and understood, below is an excerpt from an article by Stephen Elias who has written many books about foreclosure, short sales and more. He has authored so many legal books Amazon has given him his own page. Mr. Elias' work has been featured in the New York Times, Wall Street Journal and more. If you would like to read the entire article found on Nolo.com, just use the following link: Stephen Elias on Nolo.
The IRS learns of the deficiency when the lender sends it an IRS Form 1099C, which reports the forgiven debt as income to you. (To learn more about IRS Form 1099C, read Nolo's article Beware the IRS if Your Creditor Writes Off or Settles a Debt.)
No tax liability for some loans secured by your primary home. In the past, homeowners using short sales or deeds in lieu were required to pay tax on the amount of the forgiven debt. However, the new Mortgage Forgiveness Debt Relief Act of 2007 ( H.R. 3648) changes this for certain loans during the 2007, 2008, and 2009 tax years only.
The new law provides tax relief if your deficiency stems from the sale of your primary residence (the home that you live in). Here are the rules:
- Loans for your primary residence. If the loan was secured by your primary residence and was used to buy or improve that house, you may generally exclude up to $2 million in forgiven debt. This means you don't have to pay tax on the deficiency.
- Loans on other real estate. If you default on a mortgage that's secured by property that isn't your primary residence (for example, a loan on your vacation home), you'll owe tax on any deficiency.
- Loans secured by but not used to improve primary residence. If you take out a loan, secured by your primary residence, but use it to take a vacation or send your child to college, you will owe tax on any deficiency.
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