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Tax Implications of Foreclosures and Short Sales

You may find yourself in the middle of a short sale, or maybe things have caused your mortgage lender to foreclose on your home. The truth is, these types of situations happen every day, and they are completely and utterly overwhelming.

Here at Maggi Tax, we have made it our business to know how foreclosures and short sales impact your taxes so that you can better understand your options no matter what situation you find yourself in.

Today, we wanted to spend a little time shedding some light on the tax implications if you short sell or have your home foreclosed on.

As with any home sale, you will need to calculate what exactly your capital gains are to know if you need to pay any taxes on the sale. But the thing about a short sale or even if your mortgage lender forecloses, the IRS actually treats either of those still as a sale. This means there may be the need to recognize ordinary income, especially if it’s ruled that you’re ineligible for an exclusion.

Short Sale and Foreclosure, What’s The Difference?

While both a short sale and foreclosure result from a borrower’s inability to make payments on their mortgage, there are some differences to understand. And that also impacts your taxes.

A short sale is a situation where you’re unable to make payments on your mortgage, but your lender has permitted you to sell your home for less than your outstanding loan balance. They will also, in this case, cancel your obligation to repay the remainder of the loan you currently have.

In the case of a foreclosure, your lender actually takes possession of your home if they don’t receive your promised mortgage payments over an extended period.

While they will possibly also cancel your outstanding mortgage balance, it can still be considered taxable as ordinary income.

What About the Tax Implications?

Foreclosure results in a cancellation of your debt. You only are required to report it as ordinary income if you were personally liable for the entire mortgage. However, you must also calculate the capital gain that happens with your foreclosure. This is generally done by finding the tax basis for your home from the purchase price plus all home improvements you made and subtracted the home’s fair market value.

And Short Sales?

A short sale is taxable in the same way a foreclosure is. Still, many lenders won’t approve a short sale if the home’s value exceeds the outstanding mortgage balance, so there are typically no capital gains that exist.

There is good news here, though! The Consolidated Appropriations Act signed into law on December 27, 2020, was designed to be a stimulus measure to provide relief for those affected by the pandemic. This means there is some ability to have some of your canceled debt forgiven.

We hope that this guide has helped you better understand the tax implications in the case of a short sale or foreclosure. If you have more questions, reach out to the friendly and knowledgeable team here at Maggi Tax. We are always here to help with any questions you may have. So, give us a call today!

 

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