Shortsale or Foreclosure: Tax Implications You Ought to Know Now

The following blog was written by Ana Anderson in response to a question received from a prospective client:

Dear Ana,

If I do a short sale or a foreclosure,  will I owe the IRS taxes?

Ivan,  South Miami, FL

Dear Ivan,

It’s quite possible you will owe federal income taxes in 2013 if you have a short sale or foreclosure that closes after December 31, 2012.

If your mortgage is “under water”/upside down (in other words, you owe the bank more than the likely current property market value) or if you are struggling to make your payments, you may need to take one of two radical steps: do a short sale or let the bank foreclose.  But, one thing is for sure, the decision should be made sooner rather than later because if you wait until after December 31, 2012, chances are you will owe income taxes!

The IRS is going to allow homeowners who go through a short sale or foreclosure a free tax ride until December 31, 2012.  They will not have any tax ramifications as long as the lender officially releases the debt, of course.  It should be noted that the lender will not likely release you from the debt unless you have proven financial hardship.  That is a whole other matter and you may ask me to address this further if you don’t know what this fully means.

But look out! As of Jan. 1, 2013, the rules are going to change: The amount a lender forgives, either in a short sale or foreclosure, on a primary residence will be taxable on your federal income taxes!!!!

Example:  Starting in 2013, if your house sells $100,000 short of what is owed on the mortgage, you would owe federal income taxes on that $100,000. You would owe the IRS $20,000 if you are in the 20 percent bracket; $15,000 if you are in the 15 percent tax section.  Obviously, I am not qualified to give you personalized tax advice.  You should discuss your tax ramifications with a qualified tax accountant or CPA before making such important decisions.

IMPORTANT:  Homeowners would still be on the hook even if the house sold in 2012, if the bank had not officially forgiven the loan in writing prior to December 31, 2012!!!

This is “… a huge issue – it will be a shock to many taxpayers after 2012,” said Mark Steber, the Florida-based chief tax officer for Jackson Hewitt Tax Service.

The law first came into affect five years ago as the housing market went bust nationwide.  The Mortgage Debt Relief Act of 2007 “generally allows taxpayers to exclude income from the discharge of debt on their principal residence,” according to the Internal Revenue Service. “Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.”

There is a cap:  Up to $2 million of forgiven debt can be forgiven this year, $1 million if married and filing separately, according to the IRS.

According to Nick Jovanovich, a board-certified tax attorney in Fort Lauderdale, “Homeowners declaring bankruptcy could escape paying income taxes on any cancellation of debt income if the debt is forgiven in the bankruptcy even if the debtor is solvent.  Bankruptcy trumps everything.”

One loophole:  “Homeowners might not have to pay income taxes on any cancellation of debt income to the extent that they are insolvent immediately before the cancellation – that is, their debts exceed the value of their assets,” Jovanovich added.

Both Steber and Jovanovich advise that homeowners give themselves as much time as possible by deciding their course of action NOW.   I can personally tell you that short sales can take a long time.  I’ve had them go on as short as 6 months and as long as three years!  But I also see that lenders are getting on board and processing them much faster.

However, even if banks quickly approve a short sale, the prospective buyer may get cold feet and cancel the contract!  This means the seller and their agent would need to start marketing the property all over again!  So, time is of essence!

Not sure what to do? Call me for a personal and confidential meeting.  We will discuss all of the options and make a decision that is the best possible solution for your individual circumstances.

Hope this helps!

Your Guardian Agent,

Ana Anderson

(Source: was referenced for some of this information.  Photo credit:   DonkeyHotey.)

This blog does not represent legal advice and is solely based on Ana Anderson’s experience in the field of real estate. When in doubt, do seek legal counsel.

Ana Anderson of, a full-time Realtor since 1980, is a licensed real estate broker and speaks from 30-plus years of experience. She would be delighted to answer any questions you may have, big or small.   Please submit your questions to [email protected]

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