You should consult with your tax advisor as to the tax implications on short sales and foreclosures and how they relate to your financial situation. In general, this is what you should be aware of:
Forgiven Debt on Short Sales
Forgiven debt is when a borrower escapes some of the debt they owe on their mortgage through a short sale process or a foreclosure sale. Borrowers may incur income tax liability for this forgiven debt which is referred to as “phantom” income.
In some states, a lender can obtain a deficiency judgment against the borrower for the difference in the amount owed on their mortgage and the amount the home sells for at auction sale. Since this may cause a further hardship on the borrower that is already losing his or her home and receiving no cash from the transaction, and put the former homeowner so far into insolvency that he or she may never recover enough to buy another home, the government has enacted new federal legislation which is a temporary (3-year) moratorium on taxation of debt forgiveness that does not exceed the owner’s basis in the home.
Foreclosure and Deficiency Judgments
A lender who loses money from the sale of a foreclosed home must report the loss to the IRS. So let’s say a home sold for $600,000 at an auction, but the mortgage was $650,000. The forced sale of the property at an auction and the fact that it sold for less than what was owed at the time of sale indicates that homeowners received no proceeds from this sale. Since the homeowner did not receive any proceeds from the sale because it was a loss, no tax is due in this scenario.
There is just a loss on the forced sale of the property. The homeowners will not be responsible for paying the difference between the $650k that was owed and the $600k that the property was sold for at the foreclosure sale. Unless the bank tries to sue the homeowner for a deficiency judgment after foreclosure (which is quite rare these days), all parties are done with the property. Not all states allow deficiency judgments so you should the laws in your state first. In any event, the homeowners take the loss of the property, start repairing their credit, and moves on with their lives.
Property Taxes
Foreclosure or Deed in Lieu
If you plan to walk away from a house and let your mortgage lender foreclose, do you continue to pay property taxes? This is a common question often asked by homeowners who own property worth less than the mortgage balance. Most homeowners are concerned that they will remain personally liable for unpaid property taxes after the bank foreclosure.
It is best to consult with our tax advisor or attorney first in these situations. However, the general rule is that taxes on real property are assessed only against the property itself and not the owner. The way it actually works is if a property owner does not pay their real estate taxes, the county tax assessor will put a lien on the property and sell the tax certificate at public auction. The purchaser of the tax certificate at the tax auction then is responsible for paying the unpaid property taxes to purchase the certificate so that there is no longer any liability owed to the county tax assessor. If a lender takes back the property at foreclosure sale its title is subject to real estate tax liability. When the mortgage lender subsequently sells REO (bank owned) property, the new purchaser must pay all outstanding tax liability in order to get clear title unless the lender is willing to pay the tax liability.
However, a lender offering a deed in lieu of foreclosure could demand that all taxes be paid as part of the negotiation.
Short Sale
Generally in a short sale transaction the lender will ask to see estimated closing costs on a HUD-1 which includes the taxes, any real estate commissions, homeowner dues, title insurance costs, and other related closing costs. The lender approval of the HUD-1 is required before the transaction closes. So for the most part, the lender will pay the outstanding taxes out of the agreed upon purchase price and write off the difference between what is owed on the mortgage and the agreed sale price less closing costs.
I am default in payments for almost a yr. due to financial hardship
i was not able to pay my mortgage. Now my house is on short sale approved by lender or investor. but beforw the short sale they want me to pay the promissory note of 12k. i told them i will not sign the contract, then they lowered it to 5k, still i told them that will not gonna happen. Is it illegal to give me a prom note before the short sale? they want that note to be paid in cash by escrow or the 12k will be pay for 60 months. I think this is very irrelevant to my situation. I have two daughters who will go to college, and they said that they don’t care if my children will not be sent to college. pls. help me
Mercie
I am default in payments for almost a yr. due to financial hardship
i was not able to pay my mortgage. Now my house is on short sale approved by lender or investor. but before the short sale they want me to pay the promissory note of 12k. i told them i will not sign the contract, then they lowered it to 5k, still i told them that will not gonna happen. Is it illegal to give me a prom note before the short sale? they want that note to be paid in cash by escrow or the 12k will be pay for 60 months. I think this is very irrelevant to my situation. I have two daughters who will go to college, and they said that they don’t care if my children will not be sent to college. pls. help me
Mercie
Hi Mercie, Its not illegal for your lender to request a promissery note before the short sale, in fact the reason why the lender would want it executed before is because they want to know how mcuh exactly they can net on the property as a whole. Promissory notes are typically long-term notes (15-25 years) with no interest. The lack of interest is a big advantage of promissory notes. If you are already in FCL I would defintlely hold off on signing that note and seek legal counsel, otherwise I would defintley try and fight this one to see how low they can get that amount down to, remember you are dealing with negotiators. If it is something that you absolutley pay then your only other option is to just let the home be foreclosed on. They are hoping to get you to pay the shortage over time, since you don’t have the money today, obviously. They don’t want to lose money just because you’re short on your sale. Also, keep in mind, if you do sign the note and don’t pay that money back, they will send you a 1099 at the end of the year, and you’ll have to pay income taxes on it. Wishing you all the luck..
hi
i’m behind with the payments and i decide to put my house up for short sale. do i still have to pay the real estate tax bill this coming june and september?
thanks
thuy
if i do foreclosure or short sale on home,suppose my home is sold for $225000 when my original mortgage is 295.so the diffrence is 70000.
do i have to pay tax for that amount?
Does Florida allow deficiency judgments when the home you live is forclosed on?
We are at the point where we just can’t pay our mortgage any more, but are concerned about being sued by the mortgage company for a defiency judgement resulting in long term liability and additional problems from the lender after the foreclosure.
what’s gonna happen in a short sale in california in 2009? Is there any extensions on the debt forgiveness for the state tax? We have a 750K loan and a buyer is offering 400K. How much will it cost us? Pls help
I am in the middle of short selling 4 of the 6 residential “investment” properties that I own. I have been told of the tax consequences that I may face regarding selling my properties for less then the mortgage. In all the 4 mortgages on the properties that I am shorting total about $700,000 but the offers I have total about $400,000. Will I be help liable for the $300,000 difference on my taxes?
In the 1st paragraph of your website for Short Sale and Foreclosure Tax Implications, you say that there is a 3 year moratium on taxation of debt forgiveness that does not exceed the owner’s basis in the home. I understood that this is a Federal law and applies in all states. Is that correct?
Also, in your answer to Mercie, you tell her that she will be liable for taxes on a promissory note if she signs one. This sounds like a contradiction to the statement above. Why is Mercie’s case different?
I sold my home in 2006 in short sale 1th and 2nd mortgage total was paid off both loans, did not get a dime from the sale. Market Value was 450,000 sold for 398, 000 can I claim the lost from the 450,000 as a write off / lost. about 42,000