Greetings, Short Sale SURVIVOR!
So, you did it! You managed to deal with the challenges and demanding process that resulted in a short sale of your primary residence. Congratulations on getting to the closing table! Not everyone makes it, and it's a testimony to your tenacity (and likely your Realtor's, too) that you have. So now you've freed yourself of a heavy burden, and that's wonderful. But you're not quite finished...
YOU MAY HAVE AN INCOME TAX LIABILITY FOR THE AMOUNT OF THE FORGIVEN DEBT: It should have been mentioned to you during the short sale process process that your lender is required to send you a Form 1099-C, Cancellation of Debt, for any balance remaining on your loan balance after the short sale (difference between what the lender was paid at closing, and the balance you owed them.) Some lenders and asset managers will not discuss this with you, or notify you of that detail, and they are not legally required to. Ideally, your Realtor or closing attorney did. In the heat of the moment, you may not have realized what this means in terms of income tax ramifications.
Yes, you're in a financially tough spot, or you wouldn't have needed to do the short sale in the first place. And yes, the IRS understands that you didn't actually get that money from the lender...
KEY POINT: The IRS considers the difference between what the lender was paid, and what they forgave of your debt at closing, as TAXABLE INCOME! For a typical short sale, that is likely 20-50% of the full debt due at closing (for example, if your loan with penalties and interest added up to $200K, and the bank NET (not the full sale price, but the amount the bank actually received, which is shown on your closing statement as a line item) was $144K, you would be taxed on the shortfall of $56K. For a typical tax payer, this could amount to almost $10K in income taxes due. Yikes.
GOOD NEWS: The Mortgage Forgiveness Debt Relief Act established in 2007 allows you to exclude income from discharged debt on your PRIMARY residence through 2012. There are other potential solutions due to insolvency, depending on your unique situation, that may help you as well. Please visit this link http://www.irs.gov/individuals/article/0,,id=179414,00.html and follow the additional links to learn more.
OPEN YOUR MAIL! You can't win if you don't play! If you receive any letters from the lender or debt collector/asset management company, please open them! You will need to check the 1099-C when it arrives, to make sure the amount is correct. Make sure your forwarding address is renewed with the post office, as mail forwarding is only good for a few months. Continue to update your forwarding address so you don't miss the 1099-C they WILL mail to you.
WHAT NEXT? Once you have the 1099-C, you can then use an additional IRS Form 982 to exempt your tax liability for that income if the short sale was for your primary residence and/or it meets criteria established by the Mortgage Forgiveness Debt Relief Act. That form is to accompany your 1099-C from the short sale, establishing the exclusion of debt. For additional information, please visit the link provided and seek professional tax preparers advice.
CAVEAT: It is vital that your tax preparer be experienced and qualified to assist you in preparing the correct forms. Expect that you will receive 1099's from each creditor (any debt settlement for credit cards will also be 1099'd by the creditor as well, so be prepared - credit card settlements may or may not fall under forgiven debt!) If you don't receive a 1099-C for each forgiven debt, DO NOT ASSUME THEY DID NOT SEND ONE. Creditors are obligated to send a 1099 for every forgiven debt over $600. Their failure to send one does not avoid your obligation to report the amount forgiven to the IRS as income. DO contact the lender/asset manager if you don't have a copy by February 2, 2012.
DON'T QUIT NOW! The short sale was a big step toward accomplishing financial peace. I know it's frustrating, but it's better to deal with it correctly and finish this task completely, than have issues hanging out there to create additional financial problems. You've come sooo far, don't quit now!
AFTERWARDS? If you are struggling with the emotional aftermath of financial loss, or want tools to gain a healthier perspective on managing your financial obligations and future income, here are some sites you might want to visit.
http://www.financial-planning-lesson.com/david-ramsey.html (offers budgeting classes, books, training CDs, etc. with a Christian perspective.) http://www.creditcards.com/credit-card-news/forgiven-debt-1099C-income-tax-3513.php Great explanation of credit card debt, and forgiven credit card debt (which is also 1099'd.) All things credit cards! Free estimator to determine your credit score (click on the unsure button about your level of credit, fill it in honestly, you should have a fairly accurate credit score range.) http://www.money-management-made-easy.com/index.html a great financial management resource that offers tips and ideas for creating healthy financial practices. All free, all kindly written, very informative with links to items of interest.
https://www.mint.com/ LOVE THIS! How about a completely free, easy, safe way to manage your accounts, create and track budgets, all in one place on line? This is it. Encrypted, must-visit site worth your time to watch the short video. Highly recommended by Money, NY Times, ABC News.
Wishing you every good thing...
Onward!
Sher
Sensible disclaimer: This information is provided as a service, and is not meant to be a substitute for legal or professional financial advice. Sher Powers is not a licensed attorney or tax planner, and is offering this information to encourage further exploration. Please consult with your attorney or CPA on any of these topics of concern to you.