There are consequences of doing a short sale whether it be in the Santa Maria real estate market or anywhere your home is located this because you owe more on your mortgage home loan than what your home happens to be worth at this time, this is when you are upside down. Don’t get me wrong there are some benefits to a short sale as well, we are just going to touch a little bit about the dark side. Keep this quick and short and to the point.
If you read my last blog then you read about the benefits of doing a short sale if you did not you might want to visit that blog since there are some benefits as to why you would want to do a short sale vs. letting your home foreclose if you do not qualify for a foreclosure. The majority of Santa Maria homes for sale and most likely in Calif. are either a short sale or a foreclosure and many homeowners may be contemplating what course of action to do whether to just walk away or work on doing a short sale.
You have to take into consideration that you owe $400,000.00 on a house that is only worth $200,000.00. What happens to the difference???
First we will talk about the IRS, the Feds and then we will talk about the impact on a state level on how they look at that $200,000.00 dollar difference. But what happens if you do a short sale does the bank eat the difference, yes.
Most reading this are probably thinking that’s cool sign me up and let’s do a short sale. The only problem is that the IRS considers any canceled debt as ordinary income, even when dealing with credit cards on working on settlements. So now the picture is not so rosy especially if you have never made $200,000.00 in your life and now looking at a tax bill of $200,000.00. If you do a short sale you will be receiving a 1099C for 200k if you do a foreclosure you will receive a 1099A, these will have to be filed with your tax return. So now what do you do? You do have a couple of choices and do please keep in mind try to go to someone that is very experienced with taxes this is not something you want to just let anyone do for you.
So here are some Exceptions to the rule on paying taxes…. Listen up 😉
1) The IRS will not collect taxes on the deficiency amount if the homeowner filed Bankruptcy and included the deficiency amount.
2) The homeowner filed insolvency at the time of cancellation of debt, which means that you owed more than what you have in assets you do not have to file BK this can be done at the time when filing your tax return.
3) If this was a rental property and you can offset debt by other business liabilities and expenses basically back to being insolvent.
If you just allow the home to go to foreclosure no worries this is straight from the IRS themselves
Update Dec. 11, 2008 — The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualify for this relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). http://www.irs.gov/newsroom/article/0,,id=174034,00.html
So now on to the great state of California, first thing one should know is that California is a non-recourse state only if your loan was purchase money more on that in another blog so if you lose your home through foreclosure it IS pretty much a done deal, the Bank cancels the debt, since this is a non-recourse state if the foreclosure is done non-judicially. But even in the state of California we pay taxes and the state is broke at this time and at this time there is NO MORTGAGE DEBT FORGIVENESS ACT. There was a forgiveness act that was implemented for the years 2007 and 2008 but nothing at this time for 2009 so if you lose your home through foreclosure you could end up owing unless you declare bankruptcy. Here is a story of a young couple facing a tax bill in Calif. http://www.insidebayarea.com/real-estate/ci_14700359. At this time California does not care if you do a short sale or a foreclosure they want money, “Tax on this seemingly “phantom” type of income is due whether the bank forecloses on the mortgage, or allows a “short sale”
There are a couple of options for your clients who are caught in this situation:
- Bankruptcy: Debts discharged in bankruptcies are generally not considered debt-cancellation income.
- Insolvency: Tax will not be assessed on the phantom debt-cancellation income if your client can prove insolvency existed when the debt was discharged. Your client must prove that all assets totaled less than all debts.
*franchise tax board
In closing the benefits usually do out weigh the consequences in doing short sale vs. a foreclosure. Biggest benefit would be when do you want to become a homeowner again. This was just a brief summary of the tax consequences involved and you will have to seek the counsel of someone that can help you with filing for your taxes. The Santa Maria real estate market will still have a few years of dealing with foreclosures and short sales as the primary source of homes on the market.