How a Foreclosure or a Short Sale can affect your taxes.
How a Foreclosure or Short Sale affects your taxes in Minnesota (MN). Bank will send you a 1099. You are protected by The Mortgage Debt Relief Act or you can claim insolvency. So either taxes are forgiven or you are insolvent.
FOR IMMEDIATE RELEASE
Oct. 29, 2009 - PRLog -- Tax laws, when it comes to debt being forgiven, are simple. If you owe a debt to someone and they cancel or forgive that debt, the canceled amount may be taxable. Does it make sense? Sure, because you have just received something that you did not have before. So, when a homeowner loses a property in foreclosure or do a Short Sale, banks will typically charge off (forget about) the mortgage loan and simply issue to the former borrower a 1099 for the amount of the loan that the bank forgave. For example, if you bought a house with a $100,000 loan, and the bank received $80,000 in a Foreclosure or Short Sale, that leaves $20,000 to collect.
Fortunately, there is good news for homeowners that purchased a home as far back as 2007. In 2007, President Bush signed off on “The Mortgage Debt Relief Act of 2007” which generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a Foreclosure or a Short Sale qualifies for the relief. However, the exclusion does not apply if you did a cash-out-refinance. The amount of equity you cashed out will be taxed. Investment homes or second homes also do not qualify.
The provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million is eligible for this exclusion ($1 million if married filing separately).
For those who don’t qualify for Debt Forgiveness, the question then might be:
Will I get sued for the loan balance after a Foreclosure or Short Sale?
The short answer is no, if you live in Minnesota. In MN the bank does not have the right to sue you for the $20,000 if
the property goes to Foreclosure sale. If you don’t live in Minnesota, and live in a state that has recourse (can pursue for a deficiency), the bank might simply forgive the debt anyways. Please check your state laws. If the bank forgives this debt, the bank will issue you a 1099 for the amount of $20,000.
But why would a bank ever forgive the debt and get nothing rather than at least try to collect something? The answer is simple: because by 1099ing the borrower, the bank is declaring a deductible loss that reduces their income tax by roughly 35% of the amount of the 1099. You see, the bank is not likely to have a collection rate as successful as the 35% that they are guaranteed to get by charging off the debt. From the bank’s perspective, it’s simple and sound economics.
Ok, so you fall in the category in which you will be 1099d because the bank foreclosed or you Short Saled your home. Breathe easy, insolvent (broke) taxpayers are not liable for “Cancellation of Debt” (COD) income, generally speaking. However, if you need help with this circumstance, you’ll definitely need to find your own tax professional because the rules are technical. The applicable Code section is 26 U.S.C. Sec. 108, which generally sates that “Gross income does not include any discharge of indebtedness when the taxpayer is insolvent” Insolvency is defined elsewhere in the code to mean a simple balance sheet calculation. Do your liabilities exceed your assets? If so, you may be insolvent. The IRS form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness covers this issue exactly, and can give relief to an insolvent taxpayer hit with a huge 1099. Explore this with your tax advisor.
We are not an Attorney, Financial Planner or CPA. Please consult with any of these before you consider a Short Sale on your home.
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Short Sale Mitigation Services is a Short Sale Negotiation Company located in Minneapolis, MN. We negotiate successful results in terms of Short Sales for Real Estate Agents and a select group of investors in the Minneapolis/ Saint Paul Metro area only.