Short Sale Debt Relief - Let's Review

Many homeowners who have opted for a short sale still seem to have a great deal of confusion over when the lender will issue an IRS 1099 form. As we described in our post A Reminder - Mortgage Workouts Are Now Tax-Free for Many Homeowners, there are specifics as to how this situation is handled and who will actully incur a tax liability.

When a lender forgives a debt in a short sale transaction, the benefit the homeowner receives is the same as if they were receiving income. Lenders that forgive all or part of the debt are obligated to issue a 1099. Here's how they are applied to differing short sale transactions:

• For Primary Residences - The Mortgage Forgiveness Debt Relief and Debt Cancellation Act is in effect until December 31, 2012. Under this law, sellers of a primary residence are forgiven up to $2 million of debt if a married couple and $1 million if single or married and filing separately. Simply put, except for extremely expensive properties, if a homeowner(s) sells their primary residence there basically will be no additional tax consequence from a short sale.
• For Rental Properties - If the property is a rental or has been rented in the past and appeared on previous year's tax returns, then the transaction may be treated as a business loss. The debt relief (income) received will be treated as a business loss by the sale of the property on a dollar for dollar basis. Essentially,for rental income properties sold at a loss there will be no additional tax consequences from a short sale.
• For Second Homes, Vacant Lots and Speculative Investment Properties - In most cases, you may take a substantial hit from the IRS, especially if you never rented out the property. Without the ability to treat the property like a rental, a homeowner cannot claim a business loss. If you lost money on the investment, you may be able to offset some of the gain with a capital loss. However, the debt relief (income) from the 1099 will only be somewhat offset by the capital loss.

The above interpretations are only to be used as a review of the current guidelines. Short sale sellers should be sure to check with their own accountant or tax advisor for specific details on how their individual transactions will be treated.

Gulf Coast Associates, Realtors specializes in upscale Florida real estate in and around Bonita Springs and Naples. For more information about our company's services, call us today at 888-617-3674.

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