Short Sales

A “short sale” occurs when a mortgage lender agrees to accept less than the total amount owed (the lender comes up “short”) and releases the borrower from all or part of the remaining unpaid indebtedness. This forgiveness of debt can result in income tax liability to the borrower. The federal Mortgage Forgiveness Debt Relief Act of 2007, however, was enacted to allow borrowers to exclude from federal taxable income debt forgiven on their principal residence. Pub L No 110-142, 121 Stat 1803 (2007). The Emergency Economic Stabilization Act of 2008 extended the exclusion from gross income for the discharge of qualified principal residence indebtedness for an additional three years. Pub L No 110-343, 122 Stat 3765 (2008). The exclusion applies only to forgiven or canceled debt used to buy, build, or substantially improve a principal residence or to refinance debt incurred for those purposes. It applies to qualified debt forgiven from 2007 through 2012, and there is no dollar limit on the amount of forgiven debt that may be excluded from income if the principal balance of the loan was less than $2 million ($1 million if married filing separately for the tax year) when the loan was forgiven. The amount of debt forgiven must be reported in IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), which should be attached to the borrower’s income tax return. The lender must send a Form 1099-C, Cancellation of Debt, to notify the borrower of the amount of the debt forgiven or canceled.