Short sales can make a whole lot of sense and certain provisions in the tax code can really help.
The swimming metaphors are so over used here but also so very appropriate. The long and short of it is, if you are drowning, dump the weight and then swim. If you made an unfortunate investment decisions with your home or rental property and the property is underwater, the federal government will not cover your loss. However, IRS code section 108 lets people in the tightest situations exclude cancellation of debt income.
First, with the passing of the Mortgage Forgiveness Debt Relief Act, you can exclude cancellation of debt income realized from mortgage modification or foreclosure of your principal residence. With this supreme act of common sense from congress, if your home is foreclosed on and you are forced to leave because you can make the payments they won’t tax you on the “gain” realized when you had to abandon your home. The long and short of this is, dump the weight, and get your head above water so you can breathe.
Additionally under section 108 of the tax code, you can also exclude any cancellation of debt income (1099-C) under a variety of situations including “Insolvency”. In IRS terms this means if your Total Recourse Debt exceeds the value of your Total Assets you can exclude the excess.
For example:
Total assets: 300K
Total debt: -450K
Excludable cancellation of debt income 150K
Before you jump, be sure to talk to a CPA (contact us) or tax attorney to understand the rules and exactly what things like “Recourse Debt” means and assess your situation.
Concerns over credit impact are not irrelevant. But, if you are driving yourself into bankruptcy trying to maintain payments on an asset that might recover in a few years, worries about impact of a short sales seem misguided. In the end, it really is just a business decision. The monikers of winning or losing or guilt really have no place here. The fundamental question is how to stay best provide for yourself and your family.
Michael White is an Austin Accountant.
I’m a fellow real estate broker from Denver. I came across your website via Carnival of Real Estate. I like your site and have gleaned a few ideas from it. Hope you don’t mind. Here’s wishing you a great 2010!
Hi,
I’ve been doing some short sale work here in Mass for about a year now. I find that the amount of work I put into deals not that never close is a killer.
However with the market the way it is it seems to be short sale, bank owned of nothing.
Thanks for the insights from Austin and I will try some of your ideas in my deals. Will let you know if they make me some money.
Thanks,
Chris
I also enjoy your blog. great info! real estate and finance issues are great to keep up to date on for insurance professional as well.
Thanks for the article Michael. I have a couple of friends that need to know this about the tax breaks. I will send them a email with the link.
eric, great site, love the topic. keep up the good work, though i don’t agree with all your comments, still good.
Shorts sales are still prevalent in so cal as well. Working quite a few but primarily for the buyers. I know how much work goes into helping someone in the short sale process as the sellers as well very go info here. Every state is different check with your account on tax issues.
Yes, but what about us still owing the bank for the difference between what the home was worth when we bought it and its current value.
The bank just sent us a $55,000 bill.
We just had to sell it for a huge loss.
There was no question of our staying in the home,and the bank wasn’t interested in a renegotiation. We have no work.
Are we saying that the Congress is not going to alleviate the debt and instead the banks who have been bailed out for hundreds of billions are going to force folks like us into bankruptcy, even though the government has helped them to such an extent that the bank executives are getting bonuses this year equivalent to 10 years of my salary?
Such a cruel place America has become, with the upper 5% always coming out ahead.
If their investments fail, the government seems to always make them whole, but we the people, the other 95% end up in bankruptcy court.
Congress even passed laws the past decade to make sure banks never take a hit by making it ten times more difficult for people like us to file bankruptcy and, as you put it, breathe again.
No such luck.
Beth –
You bring up a great point. If you’re negotiating a short sale with your lender, you need to make sure and include the provision that you are not liable for the difference in settlement.
Short sales, as we see at http://www.gohoming.com will be on the rise in 2010, especially with the influx of REO homes for sale and inability to hit the market. New laws like this will facilitate the effort.
Michael,
I am confused. The CPA I work with advised my client that the 1099 is offset by the property loss in value. For example, you bought a property for $100k with almost zero down. When you short sale it for $60k, the bank issues you a 1099 for $40k. However, your gain is offset by your loss of $40k in real estate investment. Thoughts?
Steve
The deficiency between what is owed and what the short sale sells for is a huge topic here in Florida. The banks have 5 years to collect. I’ve been working with an attorney whose entire practice has turned into negotiating short sales with banks and removing their right to collect at some later date.
Good to know about the tax breaks. I have been working with a few family members on their current housing situations, and will encourage them to discuss these tax breaks with their CPA.
Thanks for the info!