Short Sales Will Have Increased Tax Consequences Starting In 2013
An important tax provision that allows underwater homeowners to short sell their home without tax consequences will expire at the end of this month. Earlier this year I wrote about this tax provision. You can review that article here.
Briefly stated, any discharge of indebtedness (except for bankruptcy) is income that is subject to tax at the rate of the individual taxpayer’s applicable bracket. The difference between the mortgage balance and the amount that the bank was paid is simply added to your income and therefore increases your total tax significantly. For example, if you enter into a short sale with Bank of America and they agree release their lien and process a short sale for $100,000 less than your mortgage balance, you will receive a 1099 for the amount BOA forgives. Your income tax basis will then go up by $100,000.
It is unlikely that anyone who needed to short sell a home will have that extra cash to pay the income tax. Trust me, you do not want to exchange mortgage debt for tax debt and subject yourself to IRS collection activity.
A more important issue is the ability to discharge mortgage deficiencies in bankruptcy and the inability, except under very limited circumstances, to discharge tax debt. The Washington Post reported today that the extension of the tax cut for underwater homeowners is tied up in the “fiscal cliff” tax bills. Read the article here.
The bottom line: Do not enter into a short sale after December 31, 2012 without competent legal representation to discuss important options, including the need to file a bankruptcy case to avoid significant tax implications of this tax provision is not extended. Otherwise, you will likely go over your personal “fiscal cliff.”
For more information on bankruptcy and short sales, read this article.