Coping With The Income Tax Hit On "Short Sales" & Foreclosure Sales

A recent syndicated column in the Los Angeles Times gives a layperson's explanation of how the income tax law operates when a homeowner receives the benefit of a cancellation of debt when he or she sells a home on a short sale (when the sale price is less than what is owed to the mortgage lender), or when the home is sold in foreclosure and the sale proceeds are less than the homeowner's outstanding loan balance.

Also mentioned are several of the exceptions to the general rule that income from the mortgage lender's cancellation of debt is taxable to the homeowner, including the bankruptcy exception and the insolvency exception that have been discussed here in prior posts.

Also meriting attention in the column were the options that may be available to a taxpayer to pay off the tax if they have no cash to pay it (IRS Offer-In-Compromise - see IRS Form 656 & Instructions (44 pages - 3.3 MB); and Payment Plans, Installment Agreements - see IRS Form 9465).

For more on the syndicated column, see Look out for tax hit after home loss; Tax hit could follow home loss (President Bush proposes a temporary exemption. Here's a Q & A on how that might affect homeowners in distress).

Go here for prior posts on dodging the income tax on short sales and foreclosure sales.

For further information from the government on avoiding the income tax in these situations under current law, see:

• Section 108 of the Internal Revenue Code,
• IRS Publication 4681: Canceled Debts, Foreclosures, Reposessions and Abandonments,
• IRS Form 982 (this is the actual form used to claim the amount of the cancelled debt reported on Form 1099 that is to be excluded from your taxable income),
• IRS Form 1099-C (includes instructions to debtor). IRS Publication 4681