Taxes and short sale

Question: I'm trying to find out the tax implications of selling our house in a short sale. Basically, our house was on the market for 2years and after the real estate downturn, it appraised for 70,000 less that what we owed on our mortgage. We weren't in a position to keep the house and "ride it out" so we did a short sale and the bank accepted an offer of 70,000 less than we owed. I'm hoping you can tell me how this figures into our taxes. I heard that in the past, when a lender forgives a debt, it is considered income. But then more recently I heard that the government changed that tax policy for short sales. I just don't know how to find out more. Thanks for your help! Jen, Salisbury, CT

Answer: You should be okay on the tax front. Thanks to the Mortgage Relief Act of 2007 signed by President Bush you shouldn't owe taxes on the amount forgiven on a short sale of your primary home between 2007 and 2012. But the best advice I can give is for you to consult with a tax expert.

Here's the background. It used to be that the IRS would treat the amount forgiven by the bank in a short sale as income. You'd get a 1099 on the "gain." But in response to the housing crisis the tax treatment of a short sale was suspended until 2012. The IRS has a discussion of the tax treatment of debt relief here.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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