Forgiveness Law Protected Short Sellers from Income Liability
Question: Last summer we did a short sale of our home in Peoria. Our lender agreed to the short sale and reduced the amount of the mortgage loan by $100,000 in order to close the sale of our home. Although we never thought of any income tax consequences, our accountant said that we may have income tax liability for this debt forgiveness of $100,000. Is that possible?
Answer: The general rule is that any debt forgiveness by a lender has income tax liability to the borrower. In light of the numerous foreclosures and short sales during the Great Recession, however, in 2007 Congress passed the Mortgage Forgiveness Tax Relief Act (“Act”). Under this Act the owner of a principal residence, who had lost a home to a foreclosure or by a short sale, had no income tax liability for any debt forgiveness by the lender. This Act has been extended several times, most recently until December 31, 2016. Therefore, you should not have any income tax liability for the $100,000 debt forgiveness by your mortgage lender.
Note: Most political commentators do not believe that the Act will be extended after the expiration of the current extension date of December 31, 2016.