By: Michael D Siggins, CPA 6/17/10
*This article is meant as general advice and individual taxpayer's situations may vary dependent upon factors not listed in this article. Consult your tax professional for an opinion before proceeding with any large decision like short-selling your home.
Generally speaking, the amount of debt that was cancelled due to a short sale is treated as ordinary income and is taxable. The Mortgage Forgiveness Debt Relief Act of 2007 allowed amounts from principal residence indebtness to be non-taxable through the end of 2009 and the Emergency Economic Stabilization Act extended this through 2012.
What this means for you ? as long as you qualify for the following conditions, any amount of cancelled debt (What you owe less what it sells for) is not taxable income:
-the home is your primary residence
-the cancellation of debt must not be due to services performed for the lender or any other reason not directly related to a decline in the home?s value or the taxpayer?s financial condition (very unlikely)
-cancelled debt does not exceed $2 million
-debt was not obtained (usually via home equity lines of credit) above the original purchase price of the home
Example: A house is purchased for $100,000. The house goes up in value to $200,000 and a home equity line of credit (HELOC) is obtained for another $100,000. Any debt forgiven in excess of the original purchase price of $100,000 is taxable.
There are other provisions if the debt is not included under the stipulations of the Mortgage Forgiveness Debt Relief Act that have to do with the extent to which a taxpayer is insolvent and bankruptcy provisions that can potentially exclude the forgiven debt from taxable income. These are more complex and require the expertise of a tax professional evaluating on an individual basis.