If you are considering a short sale, now is the time to speak with a bankruptcy lawyer. The Mortgage Forgiveness Debt Relief Act of 2007 is set to expire on December 31st of this year.
The Act allows homeowners to exempt home debt from taxes if that debt was forgiven by a mortgage company. For example, say your house was worth $400,000 five years ago. Today, its value is $200,000 and you still owe $250,000 on it. If you choose to do a short sale and sell the home for $200,000, and the bank forgives the extra $50,000 in debt, you will not need to pay taxes on that $50,000.
While the Mortgage Forgiveness Act provides some relief for individuals, it only applies to certain property. For example, you do not need to pay taxes on forgiven mortgage debt for a new home or a home refinanced for improvements, but you may still need to pay taxes on forgiven debt involving cash-out refinancing. Also, the Act only applies to primary homes, not vacation property.
Bankruptcy: A better option for many
For many people, short sales are simply not the best option. Bankruptcy is another option to avoid paying taxes on your home debt. In fact, unlike a short sale, bankruptcy deals with all of your debt and can set you on the road to financial freedom. You may also be able to keep your home, since primary residences up to a certain dollar value are considered exempt from bankruptcy liquidation under state and federal law.
Therefore, before you sign a short sale agreement, speak with an experienced bankruptcy lawyer to learn about all of your options.
Source: San Francisco Chronicle, "Clock ticking on forgiven-debt tax break," Carolyn Said, Sept. 17, 2012