Did you know that until recently, mortgage debt on a primary residence that was forgiven from a Short Sale or Foreclosure could be counted as “taxable income” by the IRS?
The good news is that on December 20, 2007, the Mortgage Forgiveness Debt Relief Act was signed into law. Effective from January 1, 2007 through December 31, 2009, any forgiven or “cancelled” primary mortgage debt from a principle residence, or debt used to improve the residence, will not be taxable. The limits are up to $2,000,000 for married couples filing jointly, or $1,000,000 if filing separately. The Emergency Economic Stabilization Act of 2008 extended the time period through December 2012. You can find more information on the IRS online filing form titled Reduction of Tax Attributes Due to Discharge of Indebtedness. Be aware, however, that second mortgages (not used to initially buy your property) and home equity lines are not exempted.
If you own Temecula or Murrieta real estate as an investment property or second home, your cancelled debt will trigger a 1099-C as “income“. According to the IRS, there is an exception to tax liabiltiy when the borrower is insolvent, meaning, your total liabilities are greater than your total assets at the time of the debt forgiveness (short sale real estate closing). Many borrowers are insolvent when performing a short sale. For a detailed explanation of potential tax liability and insolvency, please visit the IRS web page about “Questions and Answers on Home Foreclosure and Debt Cancellation” and “Ten Facts for Mortgage Debt Forgiveness”. Consult with your tax account on your particular situation, and after completing a short sale, have your CPA prepare your tax return.