Great to have such a concise reference to the issue of debt forgiveness and potential tax liability. This would be a great article to include in any investors short sale presentation to a potential seller. This relieves the investor / purchaser from being the person making the representation, in fact a good thing to get the seller to initial and date acknowledging a receipt and understanding of the article.
I heard one of the gurus say that if a short sale is done and the seller gets a 1099 he doesn’t have to pay the tax if he was insolvent at the time. Guru mentioned that there is an IRS Tax code for this. Does anyone have any more information?
Taxes are avoided by being insolvent or having filed a liquidation BK, Ch 7. The insolvency is calculated prior ot the forgiveness of the forgiven debt, and insolvency is described as having more debt than assets, prior to the forgiven debt. After the debt you could be worth a ton… but it is a measure of where you would be if the debt is NOT foregiven… usually not good. If good, you pay the tax…
See IRS Publ 544 here: (read pgs 4 @ bottom and tope of pg 5)
Ron, you are confusing cap gains tax with ordinary income tax. Your are right about $500K exemption in cap gains. But forgiven debt is treated as ordinary income. In the case of preforeclosure short sale, or DIL, the ‘income’ arising from forgiven debt may or may not be exempt from tax depending on the mortgagor’s solvency or insolvency at the instant the debt was forgiven.