Avoiding Foreclosure with a Short Sale

If you're facing foreclosure, a short sale can be a way to sell your home for less than your mortgage balance. Your lender may forgive the remaining balance. However, be aware that the IRS could consider this forgiven amount as taxable income. This is known as mortgage forgiveness, and it became non-taxable under the Mortgage Forgiveness Debt Relief Act of 2007. This provision was recently extended through 2025 with the Consolidated Appropriations Act.

The Mortgage Forgiveness Debt Relief Act of 2007

Prior to this Act, forgiven mortgage debt from a short sale was considered taxable income. However, this law changed that, allowing sellers to exclude up to $2 million of canceled debt from their taxable income. To qualify, the mortgage must be for your primary residence and used to buy, build, or improve the home.

Professional Help

If you're unsure about your options when facing mortgage trouble, seek assistance from a HUD-approved housing counselor. These professionals can help guide you through the process and understand the tax implications of debt forgiveness.

Short Sale Tax Implications

Debtors must report forgiven debts on their tax returns, similar to reporting regular income. If the debt does not meet certain criteria, it may be subject to taxation. However, debt forgiven through bankruptcy or insolvency may not be taxable.

The Bottom Line

Make sure to consult with a tax professional and check your state's laws regarding canceled debt from a short sale. Taxation rules may vary by state, but federal taxation on forgiven debt is waived through at least 2025, offering relief to struggling homeowners.