If a homeowner owes more about his house than it’s worth, negotiating a brief sale provides a solution. Short sales make it possible for homeowners to sell their homes for less than what they owe. The lender, though, must agree to a brief sale. When a creditor accepts a brief sale deal, it’s agreeing to forgive the difference between what the homeowner owes on the mortgage and the prospective purchaser’s offer. The government has rules for homeowners who try to make a brief sale.
Function
Usually, federal and most state government taxing bodies taxation short sales because they involve forgiven debt. The difference between the mortgage and the price that the buyer is paying is considered that the forgiven debt, and the Internal Revenue Service considers the forgiven debt to be income for the seller. For income tax purposes, this income is handled like income from your work. The quantity of the forgiven debt is added to the seller’s overall income, also it has to be reported to the IRS at the same tax year in which the debt was forgiven.
Solution
In 2007, Congress sought a way to give tax relief for fighting taxpayers. A record number of homeowners switched to brief sales to avoid foreclosure. Congress amended the tax code by passing the Mortgage Forgiveness Debt Relief Act. Under the new rules, debts forgiven between 2007 and 2012 are excluded from federal income taxation requirements under specific conditions. First, the house has to be the vendor’s principal residence. Secondly, the mortgage must have been used to purchase, construct or make significant improvements to the house. If sellers fulfill those requirements, they’re excluded from paying tax on the forgiven debt.
Size
The temporary provisions of the Mortgage Forgiveness Debt Relief Act allow sellers to avoid taxation on forgiven debt, but they also set limitations. According to the law, the exclusion applies only to the initial $2 million of forgiven debt in a single year; the limitation is currently $1 million for couples filing separately. This includes all forgiven debts for that tax year. All forgiven debt over the $2 million limitation is taxed as income.
Factors
Along with the temporary tax relief given by the Mortgage Forgiveness Debt Relief Act, sellers can also avoid paying tax on debt relief in the event the debt is forgiven through bankruptcy. This exception is permanent and is not influenced by the debt relief behave. The IRS does not consider bankruptcy to be taxable income. This is true even if the bankruptcy leads to a creditor agreeing to a brief sale. The IRS also allows individuals to avoid taxes on short sales when the sellers can prove that they are financially insolvent. To prove this, the seller must show he has more debts than assets.
Geography
Where you live plays a role in whether you’ll be asked to pay state income taxation on a brief sale. Some states require you to report the forgiven debt as income, but other nations have followed the national example to allow for special exclusions. Back in California, state law used to require tax to be paid on forgiven debt at a brief sale just when the entire sale price was $100,000. In March 2010, however, the state expanded tax relief. According to the”Los Angeles Times,” California passed legislation that waived short sale income tax requirements for approximately 34,000 California taxpayers. The new law is effective for 2009 through 2012. California’s law provides an exclusion for the first $800,000 of debt relief for single taxpayers and couples who file joint returns. The limitation is $400,000 for couples who file separate returns.
Caution
Even though the IRS allows sellers to avoid taxation on most short sales through 2012, sellers continue to be required to report the forgiven debt. Attempting to do so can have tax implications. Sellers need to file IRS Form 982, the Reduction of Tax Attributes Due to Discharge of Indebtedness form. The form is filed alongside your federal tax return. Lenders file Form 1099C with the IRS when they forgive debt. The form contains the quantity of the forgiven debt and the home’s fair market value. The IRS finally decides whether you qualify for tax relief by reviewing the forms.