Short Sale Taxes - Shortsale Distressed Sellers

Currently, the nation is undergoing a chain of events in the real estate markets around the country. Residential homes worth a large amount of money are now valued less than on third of the value in today's marketplace. Unfortunately, this has put many property owners in a situation where the property owner owes much more debt than what the property is woth now. Understanding shortsale tax implications when short selling a property is key to any distressed seller that is looking at doing a short sale transaction.

What makes this situation even more dangerous is that many of these properties in harder hit markets were purchased with variable rate mortgage loans. Inevitably, all of these loans had a reset date the would ultimately increase the monthly payment to porportions that the property owner can not support.

When we look at the sum of the two scenarios (lesser property values and elevated debt payments) with the added real economic realities such as job loss, divorce or health issues, this makes for increased stress and worry as well as forcing the propety owner to sell the home if they cannot get refinanced successfully. When a disstressed seller is forced to sell a home or less than what is owed, this is called a short sale transaction. Many sellers do this in order to avoid a foreclosure on their credit profile.

In my experience and the experience of other industry professionals that I've worked with all agree that a short sale is far better than letting the property go into foreclosure. There are a higher percentage of people that are unable to afford the current mortgage payments regardless if the mortgage could have been refianced anyway. Most people that got caught up in the mortgate meltdown were betting on the market increase in order to sell the property to the next real owner occupant therby creating a profit spread. All of this was suppose to happen before the the mortgage interest rates reset to increase the payment to the lenders.

Even some owner occupants were betting on their jobs giving them salary raises in order to resolve the increased payments coming in the future.

Some shortsale laws were enacted by the US Government such as the Mortgage Forgiveness Debt Relief Act of 2007 to help people faced with this dilemma. This law passed in 2007, help property owners that sold property in a shortsale can completely bypass the federal taxation between the mortgage balance and what the property sold for using a short sale transaction strategy.


This law itself takes much worry and financial distress from people who need to shortsale their properties with no worry about the taxation woes of selling them. Unfortunately, though, many states have not followed suit and will still tax the difference, which can be quite large, in some cases. Let's discuss some characteristics of shortsale taxes.

To figure out if you are going to have to pay income taxes from a short sale, you need to understand what your tax basis is and the amount you owe at the short sale. The tax basis is simply your purchase price plus any capital expenses such as home improvements. Assume you buy a home for $500,000 and put $100,000 into it in improvements. Assume you refinance a few times and owe $500,000. Your tax basis is $600,000, which is more than you owe. In such a scenario, you will not have to pay income tax on the short sale relief. For most people, however, this is not the case.

Let's look at example #2: Assume you purchased a home in 2003 for $300,000 and it appreciated to $500,000. Along the way, you refinanced a couple of times and took some cash out. You now have a mortgage for $450,000 and are in trouble with the payments. The lender approves a short sale and you sell the property. You now could possibly face a large tax problem. this is what it could look like: Your tax basis is $300,000, but you owed $450,000 on it at the time of the sale. In the view of the IRS, the $150,000 debt relief is a form of income to you. You now must report and pay income taxes on $150,000 even though you didn't put a red penny in your pocket. This is why the Mortgage Forgiveness Debt Relief Act of 2007 was enacted by former President Bush so that this problem would not be a burden of the Amreican people.

Each scenario is different and anyone that is thinking of doing a short sale must get the facts. The best way to get the facts is to talk with a competent CPA and real estate attorney so that you know what makes sense for you.

Make sure to understand the Federal law and that's important, but really make sure that you understand your local State legislation so that you know how you can navigate through the short sale jungle successfully. Shortsale tax and the process can be overwhelming, it is important to work with prefessionals that work in the iondustry everyday to help property sellers facing this unfortunate circumstance. Getting educated is the best strategy to embark upon.