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Short Sale Tax Consequences

A short sale is the sale of real estate for less than the balance owed on the property. Short sales are common in today’s real estate market, where home prices have fallen and the home owner is no longer able to pay the mortgage loan. A short sale takes cooperation between the home owner and the lender to sell the property at a loss. Both parties must consent to the sale. A short sale can avoid a foreclosure, which can be mutually beneficial to the parties. The lender avoids the expense of a foreclosure and the home owner avoids the negative impact on personal credit.

Short sales were seldom used by homeowners prior to the mortgage crisis because a short sale results in a deficiency balance obligation to the homeowner. The home owner was sometimes sued for the difference between the amount owed on the home and the short sale price, or, more commonly was taxed by the IRS on the amount "forgiven" by the lender. Either way, a short sale created another heavy burden on the home owner.


In response to the mortgage crisis, the Mortgage Forgiveness Debt Relief Act was signed into law in 2007 which excludes from income a discharge of debt on a principle residence. Debt forgiven by a lender in connection with a foreclosure, refinance, or short sale in calendar years 2007 through 2012 is eligible for this relief. Up to $2 million is excluded ($1 million if married filing separately). This relief only applies to a principal residence, and does not include a second home, credit cards, or a car loan.


A forgiven debt is generally taxed as income to the tax payer, but that is not always the case. The most common exclusions of this tax are: (1) if the tax payer was insolvent immediately before the debt was forgiven; (2) if the debt was discharged in bankruptcy; or (3) if the debt is a qualified principal residence indebtedness until 2012.


If you are struggling with a home mortgage and need to walk away, consult with an experienced bankruptcy attorney and learn how the law can work for you. Your attorney can explain your options and together you can make the decisions for a better financial future.