Posted by todd on September 12, 2004 at 17:08:04:
thanks for the suggestions E.Eka
thanks for your time.
todd
Tax consequences of short sale - Posted by Tom
Posted by Tom on September 10, 2004 at 13:30:02:
Heres the scenario
Seller owes 200,000
Bank will accept 130,000 as payoff for it.
I have the deed to the property.
1)Is it true that next year, the bank will send a statement to the seller showing 70,000 ( the difference between what is owed and the agreed short sale) as additional income for them, and that they must pay taxes on it. If that is true, then that sucks for this person who i have offered to “help” All of a sudden they need to come up with about 24k in taxes.
2)Or - does this “additional income” somehow becoem my responsbility, in which case i would have to pay taxes on the 60k i planned to profit from the house, and the 70k “additional income”
- If a property is short saled, isn’t there still an unfavorable item added to their credit, as well as the possibility for the bank to try and collect the amount the note was discounted
Please help!
Re: Tax consequences of short sale - Posted by B.L.Renfrow
Posted by B.L.Renfrow on September 11, 2004 at 08:01:29:
The IRS is relatively clear on this issue: if the lender forgives the debt, they MUST issue a 1099 to the borrower for the amount of debt forgiven; it’s not optional.
Second, if the borrower is insolvent, taxes are not owed on the forgiven debt.
Most folks – not all, but most – who would entertain a short sale are going to be insolvent. Note that one does not have to declare bankruptcy to meet the insolvency test – although doing so would make one about as insolvent as you can get. (See IRS pubs. 908 and 544)
Even if the seller does not meet the insolvency test, many people would rather take a tax hit than lose their property to foreclosure. Taxes can be paid in installments. They would not necessarily have to come up with the entire tax due in the year of the sale.
As for whether the bank can pursue a deficiency judgment, I have rarely seen that done. It depends on the laws of the state (some don’t permit it), whether the loan is insured, whether the borrower has assets and the policies of the investor backing the loan. However, I would always tell a seller it’s a possibility (unless prevented by law) and let them make a fully informed decision.
As to effect on the seller’s credit, yes it’s a negative. Probably not quite as bad as a foreclosure, but still negative. It will likely be reported as “settled for less than owed.”
Brian (NY)
Re: Tax consequences of short sale - Posted by WAREIA
Posted by WAREIA on September 10, 2004 at 19:20:07:
Just having the Deed doesn’t mean your responsible for the note. If you record the Deed that could be a whole different ball game. One of two things will happen to the one responsible for the underlying financing.
Either the bank will get a deficiency judgment against the owner/seller/one responsible or the bank will write it off as a lose.
If the bank receives a Deficiency Judgment against the one responsible then it is usually because they have evidence and beleive there are other assets they can seize to repay the deficiency.
If the bank doesn’t think they can recover anything then they may choose to just “write it off” and make a claim with their insurance company to recover. In order to do that however the IRS requires that the bank to issue the responsible party a 1099 for the deficiency. You either are going to have to pay back the entire deficiency or pay taxes on it as ordinary income.
The only way that I know of to avoid either is to file for Bankruptcy and surrender the property back to the bank. At this point the bank will still have to issue you a 1099 but you are not responsible for the taxes or for repayment under Federal Bankruptcy Law.
If you are not the one responsible for the mortgage then it is not you who has the deficiency.
Real Estate Agents and Investors rarely understand any of this let alone inform Seller of the consequinces of a Short Sale. Why do you think when negotiating with the bank for a Short Sale the one responsible for the underlying financing has to fill out a complete financial statement before and offer is accepted. The bank wants to see what if any other assets are available. If there are no other assets and the bank does not have adequate insurance in place to cover the lose then you may be turned down on your Short Sale offer.
If accepted and several months later after all is said and done and the Seller thinks they have avoided all this financial and legal trouble they will get a Notice of Deficiency or 1099 in the mail. Unless it is part of a Surrender in a Bankruptcy first, they can’t have it dismissed later. Now they have to deal with the IRS, and may come after you for not informing them of the true consequinces of doing a Short Sale.
In rare cases and if you use the right experienced Real Estate Agent in Short Sales, you may negotiate to have your offer accepted without a Deficiency Judgment or 1099 issued to the Seller.
When I make offers to Banks for Short Sales through my Agent we always make the offer contingent upon No Deficiency Judgment and No 1099 being issued to the Seller. Sure I get a lot less properties or not quit as good a deal as I had hoped but there is a lot to be said for a good nights sleep.
I have two partners, one is a Bankruptcy Attorney and the other works in Loss Mitigation for a well known Lender.
Re: Tax consequences of short sale - Posted by Tom
Posted by Tom on September 10, 2004 at 18:42:30:
PLEASE Someone who knows what they are talking about respond???
Re: Tax consequences of short sale - Posted by WAREIA
Posted by WAREIA on September 11, 2004 at 19:05:42:
Great follow up Bryan. Thanks for some additional information and clairification.
The insolvency thing may be why my Realtor was able to not have a 1099 issued to the Seller I bought from.
I just found out that there is an IRS form that the Seller can fill out and include with their Short Sale packet that addresses and makes claim for insolvency.
Thank You
Hey Brian… - Posted by todd
Posted by todd on September 11, 2004 at 08:51:41:
What if the seller had his BK discharged a few months ago and I am just now starting the short sale process? Everything was included in the BK, so nothing to worry about right? What is the criteria for insolvant.
thanks for your time.
Todd
Re: Tax consequences of short sale - Posted by Dave T
Posted by Dave T on September 10, 2004 at 22:15:35:
I have read that when the lender accepts a short sale, the homeowner does not have to pay taxes on the forgiven debt if the homeowner is insolvent.
How does this play into your scenarios?
Oops - Posted by B.L.Renfrow
Posted by B.L.Renfrow on September 11, 2004 at 10:02:50:
I was confusing this post with one above. Disregard my comments about the original poster discussing bankruptcy, as that wasn’t a factor in his question.
Yes, if the BK has been discharged or dismissed, you’re in the clear to make whatever deal you can.
Brian (NY)
Re: Hey Brian… - Posted by B.L.Renfrow
Posted by B.L.Renfrow on September 11, 2004 at 09:57:22:
If the sellers’ BK has been discharged, there’s no problem. But in the above case, the poster said the Chapter 13 had been dismissed, but the debtor had then filed a Chapter 7.
As for the definition of insolvency, I’m not gonna do all the work for you 
Here’s a relevant section from IRS pub. 544:
“However, income from cancellation of debt is
not taxed if any of the following conditions apply.
The cancellation is intended as a gift. The debt is qualified farm debt (see chapter 4 of Publication 225, Farmer?s Tax Guide). The debt is qualified real property business debt (see chapter 5 of Publication
334, Tax Guide for Small Business). You are insolvent or bankrupt (see Publication 908).”
Brian (NY)
Re: Tax consequences of short sale - Posted by WAREIA
Posted by WAREIA on September 10, 2004 at 23:21:44:
I beleive my previous post explained it pretty well. One of only two thing will happen or can happen unless it is accepted by the lender in advance. Either way the Lender requires you to complete a Short Sale package to find out if you are “insolvent” so they know how they are going to treat the deficiency.
If they don’t go after you for it they will write it off. They cannot write it off without issuing you a 1099. Once that is done your problem is with the IRS. You are not releived of a deficiency burden just becasue the Lender accepts a Short Sale.
However, if the Lender sells the note for a discount that is different. I’ll do either, which ever works out best for the Seller and Myself. Notes take cash, Short Sales take a little cash and good credit.
Re: Hey Brian… - Posted by todd
Posted by todd on September 11, 2004 at 15:52:35:
Thank you so much for the response… Is there a specific article or publication I can find out more about the insolvancy issue… or is it just found in the lines of the tax code. thanks for the help you have given me, I would really like to find out as much as I can so I can learn this inside and out.
again thanks for your time.
todd
Re: Tax consequences of short sale - Posted by Dave T
Posted by Dave T on September 11, 2004 at 20:07:25:
To the point, you stated “You either are going to have to pay back the entire deficiency or pay taxes on it as ordinary income.”
I am just pointing out that your statement is not absolute for an insolvent borrower receiving a 1099-C. In case of insolvency at the time the indebtedness was forgiven, the borrower does not automatically have a tax liability on the forgiven debt.
Re: Hey Brian… - Posted by B.L.Renfrow
Posted by B.L.Renfrow on September 12, 2004 at 11:51:18:
From IRS publication 908:
“Insolvency exclusion. You are insolvent when, and to the extent, your liabilities exceed the fair market value of your assets. Determine your liabilities and the fair market value of your assets immediately before the cancellation of your debt to determine whether or not you are insolvent and the amount by which you are insolvent.”
Brian (NY)
Re: Hey Brian… - Posted by E.Eka
Posted by E.Eka on September 11, 2004 at 20:42:28:
Have you checked the references he sites?
Usually the regulations have as much detail as you’re going to get. Check Pub 908. The publication is usually more reader friendly opposed to codes or regs.
Re: Hey Brian… - Posted by todd
Posted by todd on September 12, 2004 at 17:07:05:
… I have read 908 and understand this a little better. thanks for the wisdom, and your time.
todd