Southwest Florida Title Insurance & Real Estate Blog -

Tax Consequences

This is the 8th tip of “10 Questions You Should Ask About Florida Short Sales” eBook, which is available as a FREE download.

If a Florida short sale lender cancels debt, there may indeed be tax consequences. The Internal Revenue Service treats cancelled debt as income. The 1099-C Form from the IRS gives a nutshell version of what cancelled debt means to a debtor and taxpayer in its “Instructions for Debtor”:

“If a Federal Government agency, certain agencies connected with the Federal Government, financial institution, credit union, or an organization having a significant trade or business of lending money (such as a finance or credit card company) cancels or forgives a debt you owe of more than $600 or more, this form [i.e., the 1099-C] must be provided to you. Generally, if you are an individual, you must include all canceled amounts, even if less than $600, on the “Other income” line of Form 1040 . . . .”

You may experience this scenario in a Florida short sale if the lender forgives or cancels the balance of the loan after the transaction. Let’s take a look at an example. A homeowner who owes $300,000 to Bank A on her home is able to get Bank A to agree to a short sale for a net amount of $225,000. Bank A’s short sale approval letter says that the bank “will release its mortgage lien against the property and will waive its right to pursue the borrower for the remaining deficiency amount.” As we discussed earlier, the bank could have retained its right to pursue the homeowner for the $75,000 deficiency under the terms of the Note. Instead, in this example, the bank has waived that right and has canceled the homeowner’s or borrower’s debt in the amount of $75,000.

According to the IRS code, the lender would therefore have to provide a Form 1099-C to the debtor/short seller and to the IRS; and the seller would have to claim that canceled debt as “other income.”

The rationale behind this policy makes sense if you think about it. If I were to borrow $200,000 from you, I would not be taxed on that $200,000 because the assumption is that I will repay the amounts I borrowed. I’m not realizing any income in the eyes of the IRS. If, however, you were to forgive my debt and tell me that I can keep the $200,000 without repaying it, then I would definitely have realized income.

If the IRS didn’t have this provision for canceled debt, it would be easy to get around paying any income tax at all!

This is a very important issue to consider as you contemplate whether a Florida short sale is right for you. You will find some very general guidance in those same instructions. To wit:

“ . . . [S]ome canceled debts are not includible, or fully includible, in your income, such as certain student loans, certain debts reduced by the seller after purchase, qualified farm debt, qualified real property business debt, qualified principal residence debt, or debts canceled in bankruptcy. See Pub. 4681. Do not report a canceled debt as income if you did not deduct it but would have been able to do so on your tax return if you had paid it. Also, do not include canceled debts in your income to the extent you were insolvent immediately before the cancellation of the debt. If you exclude a canceled debt from your income, file Form 982.”

You should note the qualified principal residence exemption as well as some others alluded to in these instructions that could relieve you of the need to include your short sale canceled debt10 Questions You Should Ask About Florida Short Sales as income. However, do not rely on these vague statements as guidance. These exclusions and exemptions are complicated tax matters and merit the consultation with a Certified Public Accountant or tax attorney who can provide an opinion for you on the worst case scenario and how to plan appropriately to avoid tax consequences.

If you have any questions about your Florida short sale approval, or you would like to be referred to a CPA to find out more about short sale tax consequences, please don’t hesitate to call our team at (239) 985-4142 or contact us online.

To your future,

Chris

Leave a Reply





NOT LEGAL ADVICE: This information is not to be construed as legal advice. Legal advice must be tailored to the specific circumstances of each case. Every effort has been made to assure that this information is up-to-date as of the date of publication. It is not intended to be a full and exhaustive explanation of the law in any area. This information is not intended as legal advice and may not be used as legal advice. It should not be used to replace the advice of your own legal counsel.

Winged Foot Tite, LLC is not associated with the government, and our [short sale orchestration] service is not approved by the government or your lender. Even if you accept this offer and use our service, your lender may not agree to change your loan.