This is a topic that I hear over and over every time I’m meeting with agents and investors, and it is a big misconception that the tax law changed and ALL short sales don’t have to pay taxes. That is absolutely NOT true! I have reprinted this article (with a little more in-depth explanation for you, so even if you already read it, please take a minute to read it again) and I will probably re-print it every quarter until we’re out of this mess! Please feel free to forward it to the other agents in your office, title companies, mortgage companies, everyone that you feel might benefit! (This is also part of what will be covered at the seminar next week)
On December 20th, 2007, then President Bush signed into law a measure that will change the tax effects for a homeowner in foreclosure. These are critical changes that may change your client’s outlook on a deal.
In a nutshell: If a homeowner who was in foreclosure worked out a short sale agreement with their lender, the amount of debt that the lender “wrote off” is considered as ordinary income to the seller. That means if you negotiated a $50,000 reduction in the payoff to help get the property sold, that seller would have to claim that $50,000 as taxable income on their tax returns (resulting in a potential tax bill between $7,500 and $17,500).
Some sellers decided NOT to sell on a short sale for this very reason…but that’s where this new law comes in!
It makes that “income” from written off debt NOT TAXABLE to the seller under certain circumstances! Here’s some key points:
– Only applies to their principal residence, not 2nd home/vacation/rentals/speculation. So many of our clients that are in an upside-down situation on non-owner occupied properties may still owe income tax.
– Effective for debts discharged between Jan 1, 2007 and Dec. 31, 2012 (was just extended, it was 2009)
– It applies to debt for acquisition, construction, or substantial improvement to the property. This means that if someone had refinanced and taken cash out or paid debts off, then the forgiven debt WILL be taxable. Think about it…they DID get cash out of the property that they never paid taxes on…..now they will have to.
– Forgiveness is limited to $2,000,000 (I think we’re OK there!)
– The amount of forgiven debt will be reduced from the sellers basis in the house. Most sellers will still be able to sell with no capital gains bill as long as they’ve lived in the house for at least 2 years, but people in their homes less than 2 years may still have a surprise! And for investment properties, they will either pay long or short term capital gains based on how long they held the investment.
Please remember, I am NOT an accountant, and I am not giving you or your clients legal or accounting advice, and neither should you! Anytime you have a client that asks you about the tax ramifications of ANY deal, refer them back to their CPA or attorney for advice.
To read more on the IRS website, Click Here
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