Short Sale – 1099 Repercussions

A short sale, or selling your property for less than you owe on it, may create a tax liability for you.  If the bank forgives a portion of your mortgage, you may be responsible to pay income tax on the forgiven portion.  A 1099 Income Statement would be issued and you would need to report this on your income tax as income.  This may increase your tax liability by thousands of dollars.  Before you decide to do a short sale, make sure you will not end up faced with this penalty.  Consider all the options prior to making the decision.

An example of this is, you owe $150k on your mortgage and the bank accepts a final payoff in a short sale for $100k.  The difference, $50k, is forgiven debt.  The IRS may consider that $50k to be income, to be taxed at the marginal tax bracket the homeowner falls into for the year.  Insolvency, or owing more on your mortgage than the property is worth, allows you a way out of having the $50k considered as income.  However, there is currently tax relief where you may not need to pay taxes on forgiven debt.  Consult a CPA or visit the IRS website for more information and a better understanding of how this can work for you before you make any deals or sign any contracts.

Typically, if you have one lien and go through a non-judicial foreclosure you will not receive a 1099.  Even if it sells for less money than the total foreclosure judgment, there will be no 1099.  At a sheriff sale auction, the bank is not forgiving any portion of the mortgage.  They are simply recouping as much money as they can from the sale of the house.  The bank suffers a loss on the property, leaving no income for the previous homeowner to claim as forgiven debt.  The homeowners have not volunteered to sell their property and the bank has not volunteered to forgive any portion of the debt.  If there is no agreement for a lower payoff, there is no forgiven debt, and therefore no income tax liability.

The foreclosure process is basically a form of coercion committed by the state in order to enforce the terms of a contract through the sale of the property.  This does not cause the previous homeowner to be burdened with an extra income liability.  A short sale, however, can be very effective in preventing a foreclosure and is an option many homeowners are using.  Especially in today’s rough economic climate, many homeowners are able to use the insolvency exclusion to prevent additional tax liabilities.  This is more common now than it was just a few short years ago at the height of the real estate market.

It is always best to be prepared, knowing all of your options before getting started can save you a lot of grief and expense next tax season.  Consult with experienced real estate lawyers and CPA before you make your move.  You do not want to be surprised when you go to file your taxes next year.