Question: In all the extensive discussions on your show (and Diane Rehm’s show) regarding short sales and mortgage principal write down’s by lenders I have heard nothing about the possible income tax consequences of these actions. Both involve forgiveness of debt, and I believe, under current IRS rules any debt forgiven becomes taxable income to the homeowner. (Ouch!) Maybe you could address this on the show. Thank you for a most excellent show. I am able to listen most weeks. Kathleen, Benzonia, MI
Answer: The IRS would send you an income tax bill on a home’s debt forgiveness before the housing crisis hit. But that’s no longer the case so so long as the short sale involves a primary residence. .
When the housing boom went bust Congress passed the Mortgage Forgiveness Debt Relief Act of 2007. It temporarily ruled out homeowners from being liable for the “gain” from their canceled debt. (There are a number of critical restrictions but most homeowners would qualify for the temporary tax break.) The law has been extended and it’s now set to expire in 2012. However, depending on the state the short seller could still get hit by state income tax.