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Foreclosure versus short sale: weighing the ramifications

If you can no longer afford to pay the mortgage on your home, you may be weighing the consequences of proceeding with either foreclosure or a short sale. Before you commit to one course of action or the other, consider the process involved and the tax implications of each option.

You may be feeling overwhelmed due to the stress of being unable to meet your financial obligations, but an experienced attorney can help you sort through the many details and arrive at a workable solution based on your particular circumstances.

Understanding the terms

If you have not been able to make your mortgage payments for a certain amount of time, your mortgage lender can foreclose on, or take possession of, your home. In a short sale, your lender agrees to let you sell your home for less than the outstanding loan amount.

Paying taxes after a short sale

In a short sale situation, the amount of debt your lender forgives is taxable if you are personally liable for the full mortgage. For example, if you owe $300,000 and your home is purchased for $260,000, your lender will report $40,000 of canceled debt on a 1099-C.

What you still owe after foreclosure

If your foreclosure agreement includes a cancellation of debt and you are personally liable for the entire mortgage, you can report the cancellation amount as ordinary income on a 1099-C tax form that your lender will provide to you. In addition, you will need to calculate and report the capital gain.  If you file bankruptcy, you can discharge the canceled debt so you would not owe taxes on it.

Seeking legal help

Just as you should seek counsel in contemplating either a foreclosure or a short sale, you will want to discuss other legal options. These may include a Chapter 7 bankruptcy, through which debt still due to your lending institution can be discharged, or a Chapter 13, which affords a payment plan. Remember that there is a solution to your mortgage dilemma, and your attorney will help you find it.

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