Taxes with Deeds in Lieu and Short Sales
Many lenders will allow the deficiency balance to be forgiven, but there may be hidden terms and conditions in the loan agreement that make this process more complicated. It is important to read and understand all of the terms of a loan before requesting a deed in lieu of foreclosure or short sale.
The attorneys at The Lee Law Firm can give you peace of mind. Although there are many considerations, we work to educate you and stand by you throughout the process. Before you consider a loan modification, we want you to know about the taxes associated with each.
There are tax complications that go along with receiving forgiveness in the deficiency balance. By law, whenever a loan balance over $600 is forgiven, the creditor is required to file a 1099C tax form. A loan balance provision is considered “income” under federal law, and may create a tax liability for the borrower. The tax liability is determined based on the type of the loan, recourse or non-recourse loan.
A non-recourse loan refers to a loan where the lender gets the property back if you default. In this type of loan, the IRS considers the tax consequences of a deed in lieu of foreclosure to be the same as if you had sold the property. If the property has a current market value less than what is owed on the loan, it is considered a non-deductible personal loss. Properties that have a market value higher than what is owed on the loan will show a gain. Whether this gain is taxed depends on if the borrower satisfies a two year residency requirement (IRC Sec. 121).
A recourse loan is when a lender can pursue, under original loan agreement, and collect any deficiency in the loan once the property is sold. The deficiency balance in a recourse loan is considered your cancellation of debt (COD) income. If the value of the property is less than what is owed on the loan, you will be taxed on the COD income and subject to regular income tax rates. In the case where debt is discharged as part of a bankruptcy proceeding, or if the borrower can prove insolvency, the COD is not taxable. The IRS requires such persons to fill out an IRS Form 982.
The Mortgage Forgiveness Debt Relief Act of 2007 provides for taxpayers to be exempt from paying taxes on COD income. The act applies to anyone receiving deficiency debt discharges between the calendar years 2007 to 2010.
Confused? We understand, taxes can be complicated!
Don’t worry another minute about which type of loan you have or the taxes associated, let us do all of that for you! We promise we won’t lead you astray. Let us help you figure everything out and get the ball rolling on finding relief from your mortgage debt!