Often times when a property owner owes more on a mortgage than the property is worth he/she will enter into an agreement with the mortgage company for a "Short Sale." A short sale is an agreement in which the owner sells his/her property for an amount less than the amount owed on the mortgage and the mortgage company agrees to forgive the remaining balance of the debt.
For example:
-A owes $150,000 to X Mortgage Company
-A's house is only worth $100,000
-X Mortgage Company agrees to take $100,000 to satisfy A's debt
-A sells the house for $100,000
-X Mortgage Company forgives $50,000 in debt
What people often do not realize is that the amount of debt forgiven, $50,000 in the example above, is considered "Income" for taxation purposes. At the end of the year, the mortgage company will issue tax form 1099c Cancellation of Debt to the owner. This income must be reported on your Income Tax Return for that calender year. This income, however, may be excluded from taxation.
In 2007, the Federal Government passed The Mortgage Forgiveness Debt Relief Act. This act allows a debtor to excluded the debt realized on a 1099c if the forgiveness was on his/her Principal Residence. In the above example, if the property A sold via the Short Sale was his principal residence he would not have to pay taxes on the $50,000 realized.
It is important to note that this exemption applies ONLY to Principal Residnces. Any other type of property will be subjected to taxation.
Attached here is a link to the IRS web page on the Mortgage Forgiveness Debt Relief Act for additonal information.
http://www.irs.gov/individuals/article/0,,id=179414,00.html
If you have any further questions contact me at
wclos@lawyersmichigan.com
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