Taxes can play a big role in the outcome of a short sale, particularly where borrowers are concerned. No one should undergo a short sale without understanding the tax implications of this decision, and in order to do so, it is important that you learn a bit more about short sales and foreclosures.
The Difference Between a Foreclosure And a Short Sale
When it comes to foreclosures and short sales, both occur because a borrower can no longer afford to make repayments on their mortgage, and as a result, the lender takes an alternative route in an attempt to get their money back. A short sale occurs when the lender allows a client to sell the property at less than the outstanding loan balance. When this happens, they might cancel a person’s obligation to repay the remainder of the balance, but there are times when they might approach a court for this balance.
A foreclosure, on the other hand, takes place when the lender actually takes possessions of the property after not receiving mortgage repayments for a certain amount of time. In some instances, they might cancel the outstanding balance once they have done this.
In the event that a lender opts to take the foreclosure route and cancels the outstanding debt, it is common for individuals to have to report this as an income, particularly if they were liable for the outstanding amount previously. It is also important that individuals take care to report the capital gains that they made from the foreclosure. In order to do this, a person should simply work out the gain and then subtract the total of the tax basis from the fair market value of the property.
In instances when a person isn’t liable for the remainder of the debt, they will simply need to make use of the outstanding balance, instead of the fair market value of the property.
Short Sale Gains
When a lender cancels any outstanding debt during a short sale, they will need to report this cancellation of debt to the IRS. There aren’t any capital gains issues with this sort of sale because the lender will most likely not agree to a short sale in the event that the property’s value actually exceeds the mortgage balance that is outstanding.
There was an exception that was introduced back in 2007 that benefits people who have debt that is canceled or reduced via foreclosures, short sales, loan modifications and even deeds in lieu of foreclosure. Getting to know these exclusions can help individuals decide where to put them to use when the tax year end rolls around.
You don’t have to worry about the taxman when you know exactly what is expected of you, regardless of whether you are foreclosing or going through a short sale. Remember, if you have any difficulties navigating this field, make sure that you enlist in the services of a professional so that you don’t take any chances with regards to your financial future.
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