No Income Tax on Short Sale or Foreclosure — For Now

  Question: We bought our Mesa home ten years ago. The purchase price was $320,000. Our mortgage was $300,000, interest only, payments for ten years, and then amortized over the next fifteen years. Our home is only worth $240,000 today. Although we have been able to make the mortgage payments for the last ten years, our new mortgage payments will now almost double. We cannot afford to make these new mortgage payments. Our real estate agent is trying to help us with a short sale but, if we can’t do a short sale, we will lose our home to foreclosure. Whether there is a short sale or a foreclosure, our real estate agent says that we will have to pay income tax on any money that our mortgage lender loses. Is our real estate agent correct?

  Answer: Your real estate agent may have been correct at the time that he talked to you, but a recent change in the federal tax law should eliminate any income tax on a short sale or a foreclosure of your home occurring before December 31, 2016. By way of background, debt forgiveness by a lender is generally taxable income to the borrower. In response to the housing crash in the late 2000’s, however, the Mortgage Forgiveness Debt Relief Act of 2007 was passed. This 2007 Act provided that any “loss,” i.e., deficiency, by a mortgage lender after a foreclosure or short sale on a mortgage used to purchase a home was not taxable income to the homeowner. This 2007 Act expired on December 31, 2014. On December 18, 2015, however, this 2007 Act was extended until December 31, 2016. In other words, for both the years 2015 and 2016 there will be no income tax owed by a homeowner on any “loss” by a mortgage lender after a short sale or foreclosure. Therefore, you should not have any tax liability for a “loss” by the mortgage lender after a foreclosure or short sale that occurs prior to December 31, 2016.

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