When a homeowner is unable to service the debt on their home one of the various options that sometimes is available to them is known as a “short sale.”
- A short sale occurs when the lender allows the homeowner to sell the home for less than the amount owed to the lender
- After the sale the lender generally forgives a certain amount of the loan principal
The big question after a short sale is what tax is now owed on the forgiven debt? In fall 2014 the IRS and the CA state Franchise Tax Board issued letters which led many California home owners to believe that the forgiven debt after a short sale would not be taxed by either the state or the federal government. However, last summer the IRS and CA FTB sent out further clarification letters stating that this is not always the case. In some cases, such as if the borrower is a corporation, limited liability company, limited partnership, or political subdivision of the state, it can incur both state and federal taxes from forgiven debt due to a short sale.
Also important to note that the Mortgage Forgiveness Debt Relief Act, which allows for this forgiven debt to be non-taxable, was extended through December 31, 2015 at the beginning of the year. Congress’ last minute extension of the bill could mean this positive tax treatment of forgiven debt due to a short sale might not continue in the future.
As shown by the IRS and CA FTB the interpretation of this bill seems to have changed a bit over time. Also, important to note is Congress’ changing views on the bill and the fact that it might not continue to extend it. Thus, it is important to discuss with your tax and legal professionals the tax implications of a short sale and the subsequent forgiveness of any debt principal so that you can be sure to be prepared and fully understand its tax consequences.
Franchise Tax Board https://www.ftb.ca.gov/index.shtml
**This material is for informational purposes only. This material does not purport to contain all relevant information on this topic and should not be relied upon or used in substitution for the exercise of independent judgment. Teles Properties, Inc. does not provide legal, tax or financial advice. Prior to making any decision regarding the information provided above, you should consult with your tax, legal and financial advisors.**