Short sale tax? Is this true?

Question

Under federal law, when a debt is forgiven, it can be treated as ordinary income on which tax must be paid. Thus, if your lender allows you to sell the property for $475,000, less a 2 percent commission, you will have a deficit of $34,500. According to many tax professionals, you will have to pay income tax on this amount of forgiven debt, even though you did not receive the money.

Is that statement true. Others have said you only owe tax if you borrowed more than the basis in the property. IE: Second mortgage or HELOC to buy a car.

In this example: You bought the house last year for $500,000,
foolishly taking advantage of the mortgage broker's sales pitch and
obtaining a 100 percent loan.

Leave it to the government to kick someone when they are down.

Answer 1

Yes unfortunately that's true. Forgiven debt can mean a resulting tax liability. If you were insolvent at the time, you might be able to avoid the tax.

Answer 2

Sorry to say if the home's value is less than the indebtedness amount and the lender forgives the difference you have taxable income. Ah, but there is the rub....the value of the home. I believe without a subsequent sale within close proximity to the foreclosure date it would be hard to determine the value of the home without a qualified appraisal. Might be worth your while to obtain a qualified appraisal to have a fighting chance (might be well worth the tax savings).

check this out ---
http://taxprof.typepad.com/taxprof_blog/2007/08/ny-times-doi-in.html and http://www.accountingweb.com/cgi-bin/item.cgi?id=103937

Lastly, while money might be tight, now's not the time to scrimp on good advice. A good local accountant or tax professional should help.

Answer 3

Yes. Debt forgiven is considered income and entered on Line 21 of the 1040.

However, it isn't taxable to the extent that you are insolvent.

Answer 4

You have two transactions here. One is the sale of the property and the other is the forgiveness of debt.

The forgiveness of debt is income, unless the debtor is in bankruptcy or insolvent.

The loss on the sale of the property could be deductible if it is not the debtors personal residence (ie: investment or rental property). The loss on the sale of a personal residence is not deductible.