Do a short sale, get a $20,000 tax bill

The law that exempts some forgiven mortgage debt from federal taxes expires Dec. 31. Unless Congress extends it, homeowners who do short sales or get principal reductions will get big tax bills.

By Teresa at MSN Real Estate Sep 6, 2012 7:13AM

As more underwater homeowners pursue short sales and principal reductions, they may not realize they are facing a deadline.

 

If debt you owe on your primary home is forgiven by Dec. 31, you will not have to pay federal income tax on that forgiven debt, as long as it was used to "buy, build or substantially improve your principal residence."

 

But if that debt is forgiven after 2012, borrowers will once again owe income tax on that amount. If you do a short sale and your lender writes off $100,000 of what you owed, that could mean a hefty tax bill. The same goes for foreclosure, in some states, or principal reductions that are part of mortgage modifications.

 

Post continues below

 

Photo illustration of U.S. currency & U.S. Capitol (© SuperStock)David Dayen, in an article at Salon, does the math: "A $100,000 principal reduction for a family making the median adjusted gross income of $32,393 would calculate to an additional tax bill of roughly $21,200."

Forgiven debt has long been taxable. You can read the IRS rules here. The Wall Street Journal has a Q&A about forgiven mortgage debt.

But in 2007, Congress passed the Mortgage Forgiveness Debt Relief Act, which temporarily exempted debt used to acquire or renovate a principal residence. The exemption does not apply to mortgage refinancing in which the cash taken out was used for purposes other than buying, building or renovating a home. It also does not apply to investment property. (Borrowers in those situations can escape tax on the forgiven debt if they can prove insolvency or the debt is discharged through bankruptcy.)

If you plan to pursue a short sale, you might want to start now, though it may already be too late. While new rules have sped up the pace of some short sales, others still drag on for months.

 

Some members of Congress believe that the tax break should be extended, at least through 2013. A bill to extend the tax forgiveness through 2013 has already passed the Senate Finance Committee, but a vote has not yet been scheduled in the full Senate. The Obama administration supports extending the provision.

 

 
140Comments
Sep 26, 2012 1:20PM
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How does the IRS justify taxing a valuation that never really existed?  And how do they expect to collect from someone who's so broke they're forced into a short sale?  The buyer may have originally thought there would be value in the house but time and economic conditions have proven that to be false so where is the value the IRS is taxing?

So if I tell you my 1970 Dodge Dart is a classic and worth $100,000 and you buy it then figure out it's just an old piece of junk who's engine won't start and the wheels fall off, if you get the debt forgiven where is the gain to be taxed?

It's so sad that the IRS is stooping so low as to go after folks who are barely staying out of bankruptcy.

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The comments on here from some people wanting a free ride are absolutely amazing and that mentality is why this country is in the economic death spiral it is in. For nearly a decade many people bought homes too expensive for their means while they and others then used their home and its mortgage as an ATM machine taking out second and third loans, refinancing mortgages to use equity to buy stuff (Cars, motorhomes, boats, Motorcycles, second homes, etc.) They drained their equity to zero and then when the economy turned all of a sudden they are upside down.

 

Fast forward to today: Now many of the same people are finally facing the reality of what their outlandish lifestyle years ago has led to today with no money and a possible loss of home for those that can't make monthly payments.

So it begs the question as to whose fault is this and who should pay for their mistakes? And that is where I find it amazing for people who blame the banks... blame government... blame politicians for their own financial ineptitude. No one had a gun at their head when they signed up for all their loans and bought all their 'stuff'. And if they weren't savvy enough to read the fine print in the loan documents and be able to project out future revenues (income) vs. expenses with a strong cushion for disasters, then I say; Oh well that is your problem!!! Not the Government... not the bank... and clearly not mine as a taxpayer. And relating to the gist of this article, if a bank agrees to a short sale on your house, you are receiving passive income that is taxable so you need to pay it, unless you are lucky enough to live in one of the States (most likely one of the left-wing states) that has laws that forgive such income. Bottom line it makes me want to puke when I hear people expecting the government to pay for their mistakes. if that same moral compass was in place 225 years ago when the constitution was ratified, this country would have long ago gone down the toilet! 

Sep 22, 2012 8:52PM
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So...if my house is now worth less than what I paid for it and I can no longer make my mortgage payments, for whatever reason, and my mortgage lender agrees to a short sale, I am tax liable for the difference if it is written off!

 

That means that my government,who was instrumental in causing the collapse of our economy, is now going to tax me for a written off debt that they were instrumental in causing.

 

Man...I sure wish I had run for Congress instead of spending so many years defending the buggers who have put these burdens on us poor regular folks.

Sep 22, 2012 4:14PM
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Keep in  mind that if you go through foreclosure in most states you won't have a tax .
Sep 22, 2012 2:33PM
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You aren't  paying money on a loss!!!  If you borrow money-Say $100,000, pay back say $80,000 and then ask to have $20,000 forgiven, that $20,000 is (passive) income.  It is income that you spent to buy a house, but it's income non the less.
All the people saying "through no fault of my own"  I lost my job, can't make my mortgage, whatever; when you buy a house and procure a loan to do so, you are taking a risk.  If you didn't realize that when you got the loan and bought the house, shame on you.  Since bad things happen all the time, using this "through no fault of my own mentality", everyone would be foolish to buy real estate.  We should all be renting, in case something tragic happens.
Sep 22, 2012 12:29PM
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Wow, this has been very educational for me.....thanks. can we add some things here.  seems there are a lot of people out there that think that the bank is not at fault at all should you not be able to meet your contract obligation to them. interesting. maybe they should have been more diligent in giving out the loan in the first place, I met their criteria and they gave the loan. so, when they make a bad investment in me because of the economy it's my fault, but they get bailed out for making thousands of bad decisions and I only made the one.  yet I get stuck with the penalties and they get bailed out while wrecking the economy of not just here but we're global now.
and now I can only get a job(s) that pay around 30% less in wages since I'm now competing with the global marketplace I have trouble meeting my obligation to the bank.  but let's think large here.  I'm not the only one in this situation.  there are 12.5 million people out of work and 3.8 million jobs, do the math.  not everyone is going to be able to do what is right.  now what?  our economy is 67% dependent on people spending money for revenue.  if I don't have it to spend on what's necessary, I certainly don't have it to spend on luxuries, like a vacation or new car.  revenues slow and more unemployed but the banks are sitting on close to 2trillion dollars they are not loaning out and for good reason now, no one makes enough to buy anything anymore.  but there are those that support this, letting jobs go overseas and feeding their economies while we are just asking for a level playing field.  I'm not asking for a bailout, grant, handout or help from friends and family but I would like to be able to now move on to something more affordable at today's prices without getting dinged due to something that was beyond my control but was certainly in their control and they choose to help the corporations but not everyday people that actually run this economy.
the programs for home loan help from the govt is a joke. do your homework.  it is at the whim of the lender if they want to participate or not.  I've tried everyone of them while still meeting my obligations but no help.  there is no incentive for them to help.  if they foreclose or go the short sale route, the govt makes up the difference, how is that fair?
so, stop watching fox news or any other for that matter and do your own homework.  fact is they (fox news) have this set up perfectly to lie to you  See Florida Feb 2003 court findings.  they admit they can lie and distort the news, so what's the problem?  now most everyone does it.
and from me to you who are not faced with this situation, you are truly blessed, but I am no less an upright individual because this has happened to me.  I appreciate things so much more and pass judgement on others far less than before.....

Sep 22, 2012 10:55AM
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If I take a loss in my investment account then I don't have to pay tax, but if I take a loss on my home I do....WTFF????  We can not let these f'ing crooks get away with the biggest heist in f'ing history. 
Sep 22, 2012 10:12AM
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The wife and I purchased our home and  made every payment on time for years. We both lost our jobs.  Savings....gone.....401K....gone just to keep mortgage payments, food on the table and the lights on.  Now here I am at 55 years old with nothing.  The wife and I are getting divorced, impending forclosure.  I am sorry I don't have a silver spoon in my mouth like some of you apparently do but until reality slaps YOU in the face and YOU are facing living under a bridge you will never understand.  And believe me America,it can happen to you too.  I have held down a job since I was in high school, always pulled my weight.  So now I learn I may be slapped with a huge tax bill because I have no money.  Only in America folks.
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For all those that say short sale losses should NOT be taxed as income tax gains I say this:

 

1) I pay my mortgage on time every month

2) I never took out a mortgage in the first place that I new I could not pay back under the terms I agreed to and read all the fineprint BEFORE I signed up

3) I have never taken any "HANDOUTS" from anyone-- government, banks or family

4) I am nothing special as this is what every AMERICAN should do- Period!

 

Now for those that are involved in a short sale I guarantee none of the above apply to you, so you are asking a bank to forgive your debts (while the rest of us not-so-special people) continue to pay our debts. And then on top of that, you are asking the federal government to forgive the taxes on the amount that the bank is effectively giving you for free. Again, this is while the rest of us pay our taxes without asking forgiveness.

So let me leave those in this situation with this thought; Why should the rest of us that think ahead, play by all the rules, pay our fair share now be asked to pay for you too? Maybe we should all just quit our jobs, stop paying mortgages and other bills and go for the government ride with you. Now doesn't that seem fair/

 

 

 

Sep 22, 2012 7:02AM
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You got the money, pay the tax. Pretty simple.
Sep 22, 2012 6:58AM
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Seriously, I owned a home for 12 years, moved to another state for a job, paid a huge down. then my wife and I both got laid off within a year of each other when both of our jobs were outsourced overseas. together we made 120K for a family of four. after a year got a job and then my wife also, making 62K together.(we also started a couple of home businesses to try and make it work) we are not slackers.  we went through our 401K, and savings trying to do the right thing. we decided to sell and look for something more affordable, which was out there due to the down turn of real estate in the area because two plants got closed down and outsourced, one to China, the other to Korea. but we couldn't get anything near what we paid for our home. So, I'm out a huge down payment, and have a home that I can't afford but I can't sell it to do the right thing and downsize because the realtors say it will go for about half what we paid for it now. Also, we only have one bill outside of general living expenses, our cars are older and paid for and we go on vacations.
so, if we were a business, we could sell and write this off as a loss but since we're not, we get a tax bill for a short sell.  This comes as no fault of my own, but if corporations are now people, then people should be able to do what corporations do and write them off. I'm not asking for a handout.  but I take exception to a government that gives companies a tax credit for outsourcing jobs overseas and bailing out companies because they aren't making their profits because of an economy they created. Why are people so quick to bail out companies or let them write things off but hold the people accountable. either let me write off my loss or let them do what I have to do. I'm not good with this form of socialism - where we privatize the profits for companies and socialize the losses.  So, I'll continue doing what I can to keep my word, but I'm sure they won't because they get to change the laws to protect their interests and not have to keep their word.

Sep 22, 2012 6:36AM
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I think circumstances vary from buyer to buyer and it should be looked at in that manner.
Sep 22, 2012 4:02AM
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Thats only fair for them to whacked with the tax. To whom much is GIVEN much is REQUIRED.
Sep 22, 2012 3:22AM
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You buy a house, the bank loans you "x" number of dollars - based on a number of factors including your promise to pay.  Then, you pay the seller "x" number of dollars.  Usually it's close to the same amount.

How is your financial situation the bank's fault?  Go back to the seller and demand your money back it's the seller who got the money, not the bank.  All the bank got was your worthless word that you would pay.

Let me know how that works out for you with the seller....
Sep 21, 2012 11:33PM
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Maybe I am looking at this the wrong way but I think things are backwards.

The reason the banks were in trouble is because they made toxic loans. Or bad investments. But when banks make bad investments, we the tax payer bail them out. Did they have to pay tax on the money we gave them? I don't think so.

Homeowners have to pay tax on losses from bad investments, but banks don't

The political gurus who came up with the bailout plan should have given the bailout money to the homeowners with the stipulation that it be used to pay their mortage. Then the banks would have recieved the money for the bad investments they made and the homeowners get to keep their home.

But they gave the too big to fail banks the money and then the banks started taking back the homes that we tax payers already paid them for.

BTW if they are too big to fail then the must be a monopoly, and shoud be broken up into smaller not to big to fail businesses.

Sep 19, 2012 4:11PM
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Calmike did not like my answer.  So let's try this again Calmike.  What about actually saving for a rainy day instead of buying a house you cannot afford and then loosing it to the bank.  Since I have owned more than 4 residences at one time (paid cash for all of them) people who want to blame the banks, government or even the weather for their problems make me sick.
Sep 18, 2012 9:23PM
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It is obvious from some of these posts that many do not have a clue (choose to blame the homeowner in trouble).  I purchased a home in SE Washington State and had no idea that I was going to lose my job two years later. I am a responsible, professional person  and waited until I was in my mid 40's to purchase this first home for myself.  I was fortunate enough to secure another job within a matter of weeks, but was forced to relocate to Middle Tennessee ... my new employer was unwilling to cover my relocation costs. It costs me nearly $16,000 to move myself and household goods across the country. That was in 2009. I had the house listed for nearly a year and did not receive a single offer (came down $30,000 on what I owed Bank of America [BofA]; was going to hit up my 401-k to pay the difference, if needed). I exhausted $18,000 in my savings to make mortgage payments on the house.  Finally, I had no choice, but to rent the home and yes, it has been a nightmare, unscrupulous rental agencies, tennants growing pot in my basement, damages to the property, etc. I am receiving nearly $400 less in monthly rental income than my monthly mortgage obligation.  Because it is now considered an income property (BofA informed me that it would be considered an income property regardless of whether I rented it or not, because it is no longer my primary residence; I no longer live in it).  I can not refi the house because it has dropped in value and the necessary equity in an income property to refi it is much higher than normal.  I relisted the house for several months as a short sale. My realtor finally threw up his hands and walked away because BofA made he process so cumbersome, and potential buyers did not want to deal with the hassle of a short sale.  One of my co-workers in a similar situation with BofA (also relocated across the US to accept her job);she had three short sales offers on her home in California and BofA refused all three offers.  I requested a deed-in-lieu with BofA and they said, "no".  I have had to reduce the amount of money that I contribute to my retirement (lost $100,000 of my 401k almost to the penny when the market crashed), take no vacations, do not date, etc. in order to meet my mortgage obligations.  I do not qualify for HARP because the loan is not backed by Fanny Mae or Freddie Mac; it is a BOFA mortgage. People on here making comments about those receiving entitlements, walking away from their obligations, etc. should be ashamed of yourselves. You are narrow-minded, self-serving and have no clue. BofA's appraiser appraised the house within $1,000 of the selling price, so as far as I am concerned, they are at least 50% responsible. Like them, I did not have a crystal ball and did not foresee the housing crisis or a job loss.  I read the other day that Chase Bank walked away from two bad investments in California; apparently, banks do that sort of thing all the time.  I have been unable to have a normal life for nearly four years now and there is no end in sight.

 

    

Sep 18, 2012 8:21AM
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Dont you people remember the PMI or MIP that was paid every month. I dont think banks or the feds lost money the insurance companies paid for it.....now we all get handed the bill.  Just like after a hurricane they up our premiums so someone can rebuid (usally alot nicer) of a house on the beach  in florida. Dont you just love the SYSTEM
Sep 18, 2012 8:00AM
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Hmmmm...lets see they tax our food,real etate,gas,income,electricity,phones,water,sales tax,now health care tax, autombile,personal property, the list just goes on and on....I am sure they will find a reason to tax what we dont have or have lost,  we just dont have any more :(  :(  :(
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