Some people who are mired in debt and can’t afford to continue paying their mortgage think that unloading the property in a short sale will be to their benefit. What many fail to understand is there are financial implications, both tax and otherwise, that can adversely affect the sellers after a short sale.
If you don’t want to run afoul of the Internal Revenue Service (IRS), you should learn all that you can about the potential repercussions for your tax situation before moving forward with a short sale.
What you need to know
Selling your home in a short sale may be penny wise and pound foolish if you are later presented with a tax bill you can’t afford. Then, too, by selling the house for under the amount owed to your mortgage lender, you’re left with a deficiency.
When that happens, there are two outcomes. Your lender may forgive the deficiency or take steps to force you to pay it back, with interest. That can make what seemed to be a good deal, i.e., the short sale, a really bad idea.
Suppose your lender forgives the deficiency debt. You’re relieved and ready to move on. But there is likely still trouble ahead.
Tax implications await you
While on the surface, it sounds like a good thing when a lender forgives the balance. But with a short sale, the forgiven debt is considered to be taxable income for the year the property was sold.
Under the Mortgage Forgiveness Debt Relief Act of 2007 — which was extended through 2017 — if the property was worth less than $2 million and was the seller’s primary residence, there were no further tax implications.
But that ship has sailed, as the exemption expired this year. Indebted homeowners who think they are out from under their debts can face a harsh reality when they are presented with a tax bill that they have no way to pay.
There may be a better way
Filing for bankruptcy might be a better way to proceed than a deed in lieu of foreclosure or a short sale. But the only way to make the best decision for your personal financial circumstances is to have a good understanding of the options that are available to you under the law.