There is something home sellers should be aware of when it comes to taking a "Short Sale" on your house.
What is a short sale?
That's when the lender agrees to settle for a lesser amount than what is actually owed on the house. In many cases, a bank will decide to take less if the owner has been late on mortgage payments and heading towards foreclosure. Often, a bank would rather accept a short sale, than foreclose on a home.
Here was my question to my CPA:
Is it true, that if a home seller takes a short sale on their house, will they need to claim the difference they sell the house and what was originally owed to the bank... claim it as income?
This is what she said:
The answer is, yes. Of course with any tax laws, there are always "what-ifs". One key factor is the fair market value of the house being sold. The mortgage co/bank will send out a Form 1099C (Cancellation of debt) or Form 1099A (Abandonment of Secured Property) at the end of the year. Most likely it will be a 1099A.
The mtg co/bank will list all the info on the form. If the Fair Market Value is less than the balance of the debt, taxable income will result. I have seen it happen both ways, especially if recently purchased or equity loans taken out.
So... even if a short sale might sound like an easier way out, sellers will want to be aware that they will probably end up paying the IRS for the difference, as taxable income. So, save your pennies! However, a short sale is less of a blemish on a persons credit, than a foreclosure.