Are you faced with mounting credit card debt and in the process of settling with the credit card companies, or have you already settled. Are you faced with other non-real estate debt (i.e. car loans, recreation vehicles, etc.) and are in the process of settling with the lender? Do you have a home that is “underwater” and you owe more than it is worth and are faced with cancellation of debt through foreclosure, considering a deed in lieu, or trying to “short-sale” it? If you answered yes to any of these cases, whether you settle and agree to pay them zero or less principal than the amount owed and/or the secured property is repossessed you may be unaware that this may result in you paying income taxes on the canceled or forgiven debt.
Federal tax law, and in most cases state law, consider canceled debt a form of income that is subject to income tax. The following article gives a brief explanation of how a short-sale on your home can affect your taxes before and after December 31, 2012:
If you are trying to sell your principle residence prior to December 31, 2012 via a short sale, or a foreclosure or deed in lieu is finalized prior to this date, you may not have any tax consequence. However, after this date if your primary residence is sold on a short sale, foreclosed, or given back via a deed in lieu you may be subject to federal and state income tax. This exclusion is not available for secondary residences (i.e. cabins, vacation homes, rental property).
In regards to real estate debt on secondary residences and other non-real estate debt there are options to reducing your tax burden from canceled debt by claiming insolvency. This is also an option for real estate debt on your primary residence if it is “canceled” in any form after December 31, 2012 and you are not filing bankruptcy. Insolvency, is similar to bankruptcy, and simply means if you take the value of all your assets and possessions (cash on hand, retirement accounts, real estate, cars, recreational vehicles, housewares, clothing, collectibles, etc.) are less the amount of your liabilities (mortgage debt, car debt, credit card debt, etc). While insolvency doesn’t “remove” your debt obligation like a bankruptcy or settlement, it presents the opportunity for you to reduce your potential tax burden from any form of canceled debt.
If you are looking for a real-estate agent that can assist you with a short-sale or want to see what your options are, we work with several real estate agents that we could refer you to. One of our local real estate companies that specializes in home sales (including short-sales) and home purchases is Red Key Realty, Inc. (http://www.smothersgroup.com/) in Lindstrom. Becky Carlson (651) 338-8524) or Peter Smothers (651) 210-8860 will be able to go over your options with you. Peter may also be able to assist with your options for non-real estate debt. If you are looking for other referrals we would be happy to provide them to you.
We recommend you discuss your situation with your tax professional to see if you meet the requirements of any advice stated above since all situations are unique. Please contact us at (651) 257-2152 with any questions or concerns.