Question

What are the short sale tax implications — What short sale tax penalties can I expect?

Answer

Regarding short sale tax implications, there aren’t any short sale tax penalties, however, there are two main things to keep in mind:

  • You must report your property sale in the same year you do the short sale if you received one of these:
    • Form 1099-S
    • Substitute statement, like Form 1099-A
  • You might have cancellation of debt income the year the lender decides to cancel or forgive your loan balance.

Also, if you claimed a first-time homebuyer credit, you must report the sale.

When you report your property sale in the year of the short sale, report these items on Schedule D:

  • Residences
  • Personal-use property
  • Investment property

Report business and rental property on Form 4797. Calculate your gain or loss by subtracting your adjusted basis in the property from the sales price.

The sales price depends on if you’re personally liable for the loan. Ask your lender if you had a recourse loan or a nonrecourse loan:

  • A recourse loan — This means you’re personally liable. The sales price is the lower of these:
    • The full debt outstanding by the lender
    • The fair market value (FMV) of the property
  • A nonrecourse loan — This means you’re not personally liable. The sales price will be the full debt outstanding.

Unless you have an exclusion, you might have cancellation of debt income the year the lender cancels or forgives your loan. This doesn’t always happen in the same year as the short sale or foreclosure. Report it when the lender actually cancels the debt and sends you a Form 1099-C.

Include the cancellation of debt as income if you had a recourse loan. However, you can exclude it from income on Form 982 if one of these applies:

  • You’re in bankruptcy.
  • You’re insolvent — meaning your debts are bigger than your assets.
  • The cancelled debt was for your main home.

The forms are complex, and it might affect the tax you owe. So, you should consider working with a tax professional when you exclude cancelled debt from your income.

 

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