…it may come back to bite you!
Throughout the foreclosure crisis, doing a short sale…where the bank will take a reduced payoff…has been a reasonable solution for many people to an ongoing foreclosure case. But all that changed in January 2014 when the Mortgage Debt Relief Forgiveness Act expired. Now, if you do a short sale and debt is written off…YOU COULD FACE A HUGE IRS TAX BILL.
Let’s do an example with these numbers. Total amount of mortgage debt= $400,000. Net Short Sale Proceeds $200,000 leaves a deficiency of $200,000. This amount will be reported to the IRS as 1099-c income and you could be charged for that at your effective tax rate.
Now, there are ways to reduce or effectively treat this debt, but that is on a case by case basis that requires much analysis.
One of the most disturbing aspects I see is that consumers are not being advised of this risk when they work to do short sales, even when using professionals who should be properly advising them.
A recent analysis by the Urban Institute found that about 2 million homeowners will be at risk of incurring that kind of tax liability. A congressional analysis estimates that borrowers will be on the hook for $5.4 billion in extra taxes if Congress fails to renew the tax break, known as the Mortgage Forgiveness Debt Relief Act.