The Kentucky Bankruptcy Blog has posted an article that discusses how purchasing a short sale home can impact your taxes. A short sale occurs when a homeowner and their lender agree to sell a house for less than is owed on a mortgage. Both the lender and homeowner must agree to it and doing so can avoid going into foreclosure, which benefits both parties. Short sales were uncommon before to the current mortgage crisis started happening, since the homeowner loses money and is even sometimes sued by the lender for the amount remaining on the mortgage. Homeowners could also have been taxed by the IRS on the amount of money that was “forgiven” by the mortgage lender.
The Mortgage Forgiveness Debt Relief Act was passed in 2007as a response to the mortgage crisis. It excludes debt forgiveness from a short sale from being counted as taxable income. Debt that has been forgiven by a lender due to a foreclosure, short sale, or refinance from 2007 to 2012 is eligible for the tax relief offered by the Mortgage Forgiveness Debt Relief Act. Up to $2 million can be eligible for relief if you’re married, or $1 million if filing as a single. However, it only applies to your principle residence and not a second home, a car loan, or credit card debt.
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.
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