Tax Consequences

The banks will send the IRS a 1099 once the short sale is complete, the amount forgiven by the bank (the difference between the existing loan and the eventual sale price) is considered as a gain on Recourse loans and can be taxed, however on Non-Recourse loans generally there are no taxable events.

The Mortgage Debt Relief Act of 2007

The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. This provision applies to debt forgiven in calendar years 2007 through 2012 up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately)

Is Cancellation of Debt income always taxable?

Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:

• Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.

• Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.

• Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.

• Non-recourse loans: A non-recourse loan is a loan for which the lenders only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.