Unfortunately, Congress has yet to change the way they conduct business. At the end of 2013, Congress let a number of tax breaks expire. Included in those tax breaks is the Mortgage Debt Relief Act or Debt Forgiveness Act. This act has been the only winner of all the federal attempts to deal with the country's real estate problems.
Normally, any "debt forgiveness" is taxable as ordinary income. Accordingly, if there is a foreclosure or a short sale of a property, then this creates a deficiency (which if forgiven or written off becomes taxable income). The lender will issue a 1099 for the amount charged off, and the homeowner who has just lost his house will be taxed with "phantom" income.
Under the Debt Forgiveness Act, the debt being forgiven has to meet certain conditions: it has be either purchase money, refinance of the purchase money, or money borrowed to improve the residence AND the property has to be the borrower's primary residence. Assuming the debt forgiven meets those conditions (which most loans do), then there will be no taxable income to the Borrower who has just lost or short sold his house.
The Debt Forgiveness Act has been extended over three years since it was originally introduced in September of 2007. Tucker's Tip encourages everyone to write your local congressmen since Congress has yet to grant an extension on this valuable piece of legislature.
P.S. Even if the debt forgiven from a foreclosure or short sale does not qualify as primary residence, there are still some exceptions which may result in no taxable income to the Borrower. Please suggest that the Borrower contact his CPA or tax professional.
Contact me at 434-951-0858 or Tucker@TGBLaw.com if you have questions.
William D. Tucker, III
Tucker Griffin Barnes P.C.