| Do you owe more to your bank than your home is | | | | property. This could result in a capital gain, even though |
| worth? You are not alone. In fact, falling prices and the | | | | you do not receive funds. If you have owned your |
| need to sell are pushing many into foreclosure, with the | | | | home and lived there for two out of the last five |
| banks taking over the properties. If you are facing this | | | | years, you should be able to exclude such a taxable |
| harsh situation, you may have been approached with | | | | gain of up to $250,000 if single and $500,000 if married. |
| the idea of a "short sale." A short sale involves | | | | In contrast, when there is a short sale that involves |
| negotiating with your bank to reduce the amount owed | | | | cancellation of recourse debt, the cancellation part of |
| before completing a sale. | | | | the transaction is treated separately and usually does |
| Before you consider this option, you need to be sure | | | | not qualify for the gain exclusions associated with |
| that you are not opening yourself up to a tax trap. | | | | selling a home. A complicating issue comes up in cases |
| One problem is that obtaining a reduction in your debt | | | | where there is a second trust deed, since such |
| is considered income that stands all by itself. You must | | | | secondary loans are generally wiped out without being |
| frequently report it as a separate transaction and will | | | | considered part of the sale. |
| receive a 1099-C form reminding you of this. | | | | Unfortunately, if you lose money on the sale of your |
| The "C" refers to "cancellation." Unless you meet | | | | home, there is no tax benefit. You cannot deduct the |
| certain exceptions, such cancellation of debt is treated | | | | loss or use it to offset the debt cancellation income. |
| as ordinary taxable income. | | | | One reason that drives people into short sales is that |
| One exception that allows you to dodge a tax hit | | | | they hope to salvage their credit. This makes sense, |
| resulting from a short sale comes into play if you are | | | | since having a foreclosure on your record is a serious |
| "insolvent" or in bankruptcy at the time of the sale. The | | | | issue. However, a short sale does not solve this issue |
| IRS defines being insolvent as having total liabilities that | | | | completely, since most banks will not go this route |
| exceed total assets after the debt is discharged. | | | | unless you are already a few months behind on your |
| Another exception is more technical. It hinges on | | | | payments. Your credit will be damaged regardless. |
| whether or not the debt being canceled is | | | | Nevertheless, in many cases, a short sale results in the |
| "nonrecourse." Nonrecourse debt in California generally | | | | lender granting a full release and satisfaction of the |
| refers to debt used to buy your home. Having part of | | | | unpaid debt. |
| such debt canceled should not result in a tax problem. | | | | Winding its way through Congress and heavily |
| On the other hand, when you refinance and borrow | | | | supported by the nation's Realtors is the Mortgage |
| funds against your home that are used for other | | | | Cancellation Tax Relief Act of 2007. This legislation |
| purposes, it could change the nature of the debt so | | | | would amend the Internal Revenue Code to exclude |
| that it becomes recourse debt. It is somewhat rare to | | | | from gross income amounts attributable to a discharge |
| find a lender trying to enforce this recourse by going | | | | of indebtedness incurred to acquire a principal |
| after the borrower's other assets, especially if it is a | | | | residence. It seems to apply the rules already in effect |
| short sale. However, debt cancellation of recourse | | | | in California to the rest of the country, and it does not |
| indebtedness may result in taxable income. | | | | seem to offer much help to those in California who |
| A short sale transaction may also interfere with being | | | | are being squeezed right now. |
| able to exclude a gain from the sale of your residence. | | | | Due to these rather confusing rules and frequently |
| Like others, you may have refinanced your home over | | | | unexpected tax outcomes, it may be advisable to ride |
| the years, using the borrowed funds on autos or other | | | | out the foreclosure process instead of entering into a |
| personal expenses. The resulting debt may, as a result, | | | | short sale. In any case, you need to understand the |
| far exceed the basis used to calculate a gain. Going | | | | tax effect before you act and to get solid tax advice |
| through foreclosure generally means that you are | | | | to guide you through the land mines. |
| selling the home for the total owed against the | | | | |