AVOID TAX ON DEBT CANCELLATION

HOW TO AVOID INCOME TAXES ON YOUR DEBT CANCELLATION WHEN YOUR HOME OR INVESTMENT PROPERTY GOES INTO SHORT SALE/FORECLOSURE

Cancellation of debt from a short sale/foreclosure is considered taxable income. There are certain exemptions that apply that can help you avoid paying tax on the cancellation of debt. We recommend you consult with a competent CPA or tax advisor if you have a home or investment property that subject to short sale or foreclosure.

A seller in a short-sale – protection from liability.

OWNER-OCCUPIED RESIDENCE. (special exemption).

Seller is not liable for income from the discharge of their debt on a principal residence for the calendar years 2007-2012 – up to $2.0 million if married filing jointly. ($1.0 million if married filing separately). This debt discharge could come from a loan modification, foreclosure, short-sale etc……

GENERAL RULES FOR DEBT CANCELLATION (INCLUDING NONOWNER OCCUPIED REAL ESTATE)

Debt forgiven is considered taxable income (lender will send 1099-C)

When is it not taxable:

1. Debts discharged through bankruptcy

2. Insolvency – insolvent at the time of the cancellation of debt (Liabilities exceed assets = insolvency)

3. Non-recourse loans (the lender has no recourse to go after the owner, they can only take the property back – I doubt you will see much of this one)

Form 982 must be filed with your yearend tax return to indicate items 1, 2, or 3. If you are going to use insolvency, you must be able to show your liabilities exceeded your assets at the time of the foreclosure, loan modification etc……… I would recommend the client’s use a qualified CPA to prepare the insolvency personal financial statement to ensure it is done correctly and meets current definitions.

If you have questions concerning the taxability of debt cancellation. Please contact our office for a free consultation.