If you owe a debt to someone else and they cancel or forgive that debt, the canceled amount may be taxable.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the homeâ€™s value or the taxpayerâ€™s financial condition."
Text from: http://www.irs.gov/individuals/article/0,,id=179414,00.html
But it must be your primary residence, and this is only guaranteed on the first loan if your loan is secured by other mortgages unless agreed upon in writing a 2nd, or 3rd may still come after what you owe. So it depends on a case by case basis, Whether a Short Sale is truly beneficial, and completely forgiven.
Second, laws are different in every state and especially in CA since July 2011. Google SB458 and SB931. Since July 2011, if a lender (1st or 2nd) approves a short sale, there is NO deficiency. Now, a lender has two choices; 1) approve it and they cannot collect or 2) deny it and take it in foreclosure.
It's pretty scary out there right now! You hear different things from different sources. All the answers you got here are good ones. The bottom line is when you get the approval from the bank. We need to find the exact language that releases you from further responsibility. If we don't see that in writing...we go back and keep negotiating. I physically take the approval to my sellers and show them in the agreement where they are being released. If you have a first and a second, then we find this in both approvals.
Every once in a while, the second won't be happy with the payoff and they will want a note from the seller. We work it as long as we can....but worse case, you can walk away from the short sale and let them foreclose. In California, a foreclosure is considered full payment for the liens and there is no recourse at that point.
I know you have lots of questions...and short sales have become a big part of my business in the last couple of years...so shoot me an email if you want to get some more information. I also have a short sale page on my website. Agents are all here to help, just make sure you use one you feel comfortable with and ask them as many questions as you need to!
By the way, a couple of answers to your question are answering a slightly different question, as the situation applies with 1099s being filed, by the lenders, and their eventual tax implications. The IRS HAS changed their position on this situation, to your benefit.
Again, consult a competent tax or legal authority for a more specific to your own situation explanation.
1. It is not by law but by lender and certain lenders will require that you sign an agreement that you may still be liable for the difference between the outstanding loan amount due (Total Debt and the net proceeds after all cost). The question will be if these funds are collectable and that is a question for an attorney , but if signed it will create a issue or problem that will have to be litigated or paid to the bank or investor. The other issue is if this transaction was being foreclosed with the right to difficentcy or not. In california they typically do not reserve the right for a deficency in the past. Again a attorney is the best one to discuss this with.
2. PRior to 2007 the IRS had the right taxes for the portion of debt that was forgiven. So if the loan balance was 100,000 and the value at sale received was $80,000 the tax liability would be the tax rate times $20,000. It is best to talk to a tax accountant to better explain the implications and what is needed now and what will be done when the the IRS policy goes back into effect.
Dallas Real Estate Agent, Mortgage Loan Officer, Credit repair consultant
â€“ Lynn A. Crosby
That's not exactly correct. The Unpaid Principal Balance (UPB) is the amount you owe to the lender(s) plus any legal fees, taxes, insurance, etc. they have paid on your behalf, if you have not been paying these items. In a short sale, the lender(s) agree to accept less than the full UPB (including the fees mentioned above) as payment of "less than the full amount". If your property has a loan the is the original loan used to purchase the property (NOT A REFINANCE) then there is legislation that allows for the forgiveness of the Income Tax liability that would be due the IRS on the amount of debt forgiven - there are some parameters about this having to do with when the loan was first made (year 2003 - 2007 etc.).
Having said that, there are some lenders that are requiring borrowers to sign promissory notes for the amount of debt being forgiven or something less, and there are some lenders that don't look back and just write it off. Sometimes it has to do with the amount of the loan and sometimes it has to do with the type of loan and who actually owns it. For example you might be paying your payments to XYZ Bank - but the loan is actually owned by an investment firm in Singapore...
99.9% of my business over the past 20+ months has been short sales and thus far no one has received a 1099 for the forgiven debt - nor have they had to sign a promissory note !
Consult a Tax Advisor and an Attorney.
Best of luck,
Broker & Realtor
Orange County, CA
The bottom line might be, if someone has talked you into - or IS trying to talk you into - a short sale, you'd best be careful that you don't have a recourse loan. Bear in mind also, that I am not an attorney and I am not trying to give legal advice - just sharing some things I have heard.