How Last Year's Short Sale Affects your TaxesPosted On: January 2015
It's that time of year again. With W-2's in hand, you are ready to head off to your local accountant to complete your taxes, and may even be excited to get a refund this year. As you rush out the door, you check your mail, and open a letter that you were not expecting. A form 1099-C, Cancellation of Debt, has just arrived to haunt you from the short sale you completed last spring!
Why are you receiving this form? Your debt was forgiven, wasn't it? The bank may have stated in your short sale approval letter that they waived their right to a deficiency judgment, but that doesn't mean that the IRS has forgotten. The IRS requires a lender to file a Form 1099-C, Cancellation of Debt, for each debtor who receives forgiven debt in the amount of $600 or more. Even though the debt is forgiven, the IRS still treats it as income, and you must include this form with your federal tax return. So, what do you do?
Without resistance, the IRS will automatically assume that the amount listed on the 1099-C is accurate, and expect you to include the amount as income. However, if you can prove that you qualify for an exception, then you could avoid paying taxes on the phantom income. One exception is to prove "legal insolvency." Insolvency occurs when your debts are greater than your assets. If the homeowner can prove that they were insolvent at the time preceding the short sale, they may avoid paying taxes on the deficiency.
Up until December 31, 2014, homeowners in this situation have been able to take advantage of The Mortgage Forgiveness Debt Relief Act of 2007. This Act allowed taxpayers to exclude income on their tax returns from the discharged debt that was on their principal residence. The Act applied to most homeowners, but it is now uncertain whether there will be a further extension of the debt forgiveness law. (It was not renewed in 2014 until December, and was retroactive for all short sales that occurred that year since January).
The requirement that a Form 1099-C be filed for those that have forgiven debt causes much confusion for those who are not expecting it. Other options may be available to avoid tax liability. It is important for individuals to seek out tax professionals for guidance.
*Note: If the seller is offered a seller cash incentive or seller relocation incentive that they accepted in their short sale agreement, then this is also considered taxable income.
This article is not intended to give any legal or professional advice on any subject, and no action should be taken from this article without the advice of a professional that specializes in the subject field.
Tiffany Brewington is an Illinois Realtor and Short Sale Expert with ReMax Experience in Sycamore, IL. Have a Foreclosure or Short Sale question? Contact Tiffany Brewington at (630)423-2084 or write her here.
Posted On: January 2015
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