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Are We Taxed On A Short Sale?

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Posted On: 06/24/2015

Question:

We are in a short sale situation, asking the bank to approve a sale that result in about $70,000 in unpaid debt. Will we be taxed on the money we don’t pay back to the lender?

Answer:

Maybe.

Historically, unpaid mortgage debt was regarded as “imputed income.” This is a fancy term that means if you don’t pay back $70,000 in mortgage debt the money would be regarded as taxable income.

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This is a problem because you didn’t actually collect $70,000 in the sense of a paycheck or stock dividend, and yet the government still wanted to tax the money.

The problem became acute with the mortgage meltdown. Millions of people lost their homes and could not possibly pay a tax on unpaid mortgage debt. Recognizing that there was no sense in taxing people with no homes and no money, the Mortgage Debt Relief Act of 2007 was passed.

According to the IRS, “this provision applies to debt forgiven in calendar years 2007 through 2014. 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 home’s value or the taxpayer’s financial condition.”

Savvy readers will notice an obvious shortcoming with the language above: The mortgage relief protections ended in 2014, and it is now 2015.

What really happened was that the 2007 legislation had a five-year term. It ended in 2012 but was extended in 2013 and 2014. In 2014, the mortgage-relief extension was not actually passed until late December 2014, meaning total uncertainty until the last possible moment.

Now, in 2015, we once again have the same situation. Will Congress again extend the bill? Will it extend it permanently, so that the annual ritual of a last-minute extension can be ended?

We don’t know. However, at this moment two bills to resolve the issue have been introduced in Congress: H.R.1002, sponsored by Rep. Tom Reed (R – New York) in the House and S.608 sponsored by Sen. Debbie Stabenow (D – Michigan) in the Senate. If passed as written, both bills will extend mortgage-debt relief through 2016.

Right now, as of this moment, there is no mortgage debt relief legislation in place, but the situation could change – hopefully before the end of the year. For updates and specifics, speak with a tax professional.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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