Short Sale Tax Exemption Could End Soon

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Short Sale Tax Exemption / Mortgage Debt Relief Act of 2007 is set to expire on December 31st, 2012. If you’re wondering what I’m talking about and have had any portion of the mortgage on your principal residence forgiven by a lender or plan to in the coming year, you should read this article. For more information on Short Sale Tax, visit our article: “What is the Short Sale Tax?”

For the last 5 years, the Mortgage Debt Relief Act of 2007 has allowed borrowers who fall into this category to fill out a form come tax time that keeps this forgiven loan amount from being taxed as income. Without this Act, these borrowers could have faced a potentially huge tax bill. But as of 12/31/2012, this exemption will be no more, except by an act of Congress.

Let’s use “Bob” to illustrate in practical terms what the above means. Let’s say Bob had a home worth $150,000, but owed $350,000 on his mortgage. Let’s also say that Bob was fortunate enough to short sell his home for $150,000, or had a principal reduction to $150,000. Normally (outside of the last 5 years), Bob would be liable (for tax ramifications) for the loan amount that is forgiven by the lender, in this case $200,000. The tax bill on $200,000 could potentially be $20,000 to $70,000. Luckily for Bob and any one else who has forgiven debt on their qualified principal mortgage in the last 5 years, Bob could simply fill out Form 982 with his normal tax return and be relieved of the short sale tax obligation. But at the end of this year on 12/31/2012, that provision will expire. It is unsure whether or not it will be renewed for 2013. Keep your eyes open for this potential development.

What should I do with this information? As always, for current information on this and how it could impact your tax liability, consult your tax professional for the tax questions, and your professional real estate agent for the details on how and when to sell your home. For more information on the short sale tax, and more specific implications head to IRS.gov.

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