If you are a real estate professional that deals with sellers who are trying to sell their home short than one of the most asked questions you probably get is regarding the tax implications of the short sale. Up until now I haven't had a very good answer or a direction to point a homeowner regarding this topic. But now I do and so do you.
The Internal Revenue Service publication that handles this exact situation is Publication 4681. The name of it is Cancelled Debts, Foreclosures, Repossessions and Abandonments. Although it doesn't say short sales, a short sale is a cancelled debt.
In a short sale of a house, the cancelled debt is the difference between what is owed and what the bank gets at settlement. When the bank agrees to this loss and the homeowner does not have to repay it, they will almost certainly report the cancelled debt to the IRS. The question is does the homeowner now have to report the cancelled debt as income on their tax return. Prior to 2007, the answer was yes but Congress changed the code and now the answer is a little more complex.
Here is an easy to understand explanation of what the publication says:
If the loans were the original loans on the property and the house is your primary residence, you do not have to claim the cancelled debt as income.
If you refinance the loans and used any excess money to improve the home (and you can prove it) than you do not have to claim the difference as income.
If you used your house as an ATM and took money out to buy a car, vacations, clothes, pay off other credit cards, etc, than you will have to claim the amount that you took out that wasn't used directly to improve the property as income.
If the house is not your primary residence, than you might have to claim it as income but that is much trickier and you should consult an accountant.
This is just an explanation of what the publication says and is not accounting or tax advice and you should always consult a tax professional if you have any questions.
But IRS Publication 4681 is definitely a publication you should consult concerning the tax implications of a short sale.
Good one and very informative related to tax and is very useful in filing tax returns.
Thanks for the information
Posted by: Katherine | September 07, 2009 at 05:11 AM
Great!, i like it so much, thanks to post it.
Posted by: NRI Real Estate | September 08, 2009 at 12:45 PM
tax implications are a big when it comes to short sales so be very careful of how you do the transaction
Posted by: VA Refinance | September 14, 2009 at 10:51 PM
With this last comment 'be very careful of how you do the transaction' can you provide more details on what you actually mean, or point me to a website where I can investigate further. I am in the process of doing a shortsale on an investment home - difference is $110K and obviously I want the best tax outcome for myself.
Posted by: Sho | September 25, 2009 at 07:06 PM
I'm glad that you have called attention to the taxes of short sales. It is often looked over when someone is making an investment, then there are problems with the outcome. I try to educate buyers on short sales through my site, http://www.teamaguilar.com/short-sale-taxes.html.
Posted by: Team Aguilar | September 28, 2009 at 06:23 PM
Good analysis and great explanation of reasons and solutions.
Deirdre Gonzales
Posted by: Philippines properties | September 30, 2009 at 03:37 AM
Very useful post and clear breakdown of the publication. Tax implications is a important question for short sales and its great to have a way to clearly answer it to clients.
Posted by: Richland Chambers Lake | September 30, 2009 at 02:09 PM
Thank you for the publications and breakdowns, tax implications on short sales is valuable information for my clients.
Posted by: DFW Cash for Homes | September 30, 2009 at 03:24 PM
Good article and provided content I as a REALTOR was not even aware of.
Posted by: San Antonio Real Estate | October 03, 2009 at 12:38 PM
It's nice to read posts like this as it makes those complicated real estate terms simpler and understandable. Thanks for sharing and keep up the good work. By the way, I know a real estate coach who could also help many in the real estate industry make money despite the current crisis.
Posted by: Janney | October 09, 2009 at 01:12 AM
Very informative blog. I will bookmark this for future implementation with my Real Estate endeavors.
Posted by: Realtors | November 16, 2009 at 12:19 AM
Very informative. Upon reading your post I understand the whole system clearly now. Thanks!
Posted by: Primary Work at Home | December 26, 2009 at 07:16 AM