Knowing your Tax Ramifications from Massachusetts or New Hampshire Short Sales

Knowing your tax ramifications from Massachusetts or New Hampshire Short Sales


tax ramificationsI had the excellent pleasure today to interview Joe Craft, CPA about the tax liabilities for short sales.  Joe is an amazing accountant and our personal accountant at Short Sale Mitigation, LLC.  We felt it was important for homeowners to get this timely and valuable information as many 1099C’s are being generated this month and will affect certain homeowner’s tax returns.

Short sales are risky and scary for most homeowners, but being armed with valuable information regarding all possible outcomes usually sets homeowner’s minds at ease.  The alternative is far more devastating than the risk of a short sale, but knowing ahead of time what you face assists homeowners and agents in making the best decisions possible.

You can download the 20-minute interview here.

Short Sale Mitigation – If we buy a home for $125,000 in which the homeowner owes $200,000 and the lender says we “forgive the debt” what happens tax-wise? 

Joe Craft, CPA – Lender issues 1099C to the borrower and to IRS to report the cancelation of the $75,000 debt and report that as income to the borrower.

Short Sale Mitigation – So this now becomes a tax liability? Depending on the situation?

Joe Craft, CPA  – Potentially. There are a number of provisions that provide
for that income NOT being taxable.  If none of the provisions apply then it is taxable.  Usually, more common provisions cover it. Usually, owner-occupied homes or principal residences fall under the Qualified Principal Residence Exclusion which provides that any amount used to acquire the property, or any debt used to improve the property, then that debt is non-taxable. That law is in effect until 2012.

Short Sale Mitigation– Only purchase money applies? How about an 80/20 purchase or if the homeowner pulls out home equity?

Joe Craft, CPA  – Let’s start with 80/20 – That can be traced to the purchase so that would not be taxable,  but on the other hand if a homeowner borrowed against equity to satisfy other debt, i.e., credit card, that would NOT qualify. It must be to purchase or improve the property to qualify.

Short Sale Mitigation– So if the home equity was used to pay other debt, such as a car or credit cards, is there any other provision that a homeowner could qualify for so they won’t have to pay taxes on the line?

Joe Craft, CPA – Insolvency provision says the taxpayer must be legally insolvent then their cancellation of debt income is non-taxable. So then the question becomes what is the definition of legally insolvent? So you would have to add up the value of the taxpayer’s assets as of the date the debt is canceled or forgiven and then add up the taxpayer’s debts. If the debts exceed the value of the excess, the debt would be non-taxable. So for example; On the date, the debt is canceled the taxpayer owns assets worth $500,000 and they have liabilities in excess of $650,000 (and this is all debt; car loans student loans, credit card, mortgage) then the first $150,000 of debt cancelation income is NON-TAXABLE. There are other provisions that would help such as bankruptcy. No debt cancelation income is taxable when a homeowner is in bankruptcy. The first thing you look at is that.

Short Sale Mitigation – What if one spouse claims bankruptcy and the other doesn’t? Is the husband liable for taxes on the forgiven debt?

Joe Craft, CPA  – if none of the other provisions are applicable, then yes the husband would have to pay on the forgiven debt, but also they file jointly the wife then indirectly becomes liable for that debt as well. You would want to explore them possibly filing separately.

Short Sale Mitigation– Massachusetts and New Hampshire are recourse states.   These exclusions fall under the mortgage debt forgiveness act which is only in effect until 2012. Any thoughts on if it will be extended?

Joe Craft, CPA – it’s tough to say. I wouldn’t base my planning around it being extended.

Short Sale Mitigation – What about a second residence?  Homeowners immediately think that the forgiven debt is taxable. Is that true?

Joe Craft, CPA – Not always. You have to look at insolvency and other exclusions that may apply.  If the residence is connected to a farm or business, there may be a limited exclusion but those are uncommon.  I would always look at insolvency.

 Short Sale Mitigation – Is the 1099C generated in January of the following year?

 Joe Craft, CPA – Yes, and the IRS gets a copy as well.

Short Sale Mitigation – What about form 982?

Joe Craft, CPA  – it attaches to the homeowner’s taxes. When they file their personal income tax, they must complete 982 to take advantage of any of these inclusions.

Short Sale Mitigation– What about a homeowner’s tax bracket?

Joe Craft, CPA  – If any portion is taxable it’s taxed at their regular tax bracket. 

Short Sale Mitigation – If a homeowner is considering a short sale in New Hampshire or Massachusetts, what is the first step they should consider regarding their taxes.

Joe Craft, CPA – they need to see if any of these provisions apply.
If they are filing bankruptcy, then they don’t need to go further. Is it my main home? Then I would determine which portion was used for purchase or improvement, and any remaining debt I would ask myself if insolvency would apply. Lastly, I would check if the farm or business provision would apply. They need to get with someone to try to arrive at a good possible scenario again

Joe Craft, CPA




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