A “short sale” is a sale of a property where the sales price is less than the amount that the seller owes to the Bank or other lender. Some lenders these days will agree to accept less than the amount due on their loan. When this happens, the property is sold “short,” which means it is sold for less than the amount due on the loan.
Homeowners with loans often receive a monthly statement from their lender. As a result, such homeowners are usually very aware of the amount they owe on their loan. The only way most of these owners can sell their properties is if their lender agrees to accept less than the amount due on the loan. If the lender agrees to accept less than the amount due on the loan, the borrower may potentially still be liable to the lender after the short sale unless the lender also releases the borrower from personal liability. But even if the lender releases the seller from personal liability on the loan, borrowers can still face unexpected consequences as a result of the short sale.
Sellers can forget to think about potential tax liability they may have from the short sale. But tax consequences following a short sale can be significant. When a lender forgives a debt or any part of it, then such a forgiveness may in some cases be taxable to a borrower as income. Although this may sound surprising, it’s true.
A Borrower’s actions can sometimes make a significant difference on the tax consequences of a short sale. For example, The Mortgage Debt Forgiveness Act of 2007 can provide some borrowers with very significant tax savings. But borrowers may need to actually live in their property for a certain amount of time before they are eligible for benefits under this Act. The Act also contains other restrictions.
Tax considerations involved in a short sale or foreclosure can be complex. Most borrowers are not readily familiar with the applicable tax laws and will need to rely on a qualified tax professional in order to minimize the tax consequences of their foreclosure or short sale. Because the tax consequences may become irreversible after a foreclosure or short sale, it may be important for borrowers to get professional tax advice before their property is actually sold through foreclosure or a short sale.