Short Sales
You live in California. Most of your net worth was in real estate, which is now depressed in value. You are at a Christmas cocktail party making awkward conversation with someone you likely will never see again and you have exhausted the small talk on weather and Tiger Woods. Then the conversation moves to something that peaks your interest –“hey, I just did a short sale on my property…” At first you think he has sold his house to Danny DeVito, but then realize there is more to this. You learn that a short sale is a real estate term for selling a home for less than the mortgage balance, with the lender forgiving the unpaid balance.
The primary reason debtors consider short sales instead of a basic foreclosure is to try and protect credit history. Be aware that short sales are indeed taxed under the same rules as foreclosures. You should consult your attorney first to determine the status of your mortgage – is it recourse or nonrecourse? If it is recourse, you are personally liable for the debt. If it is nonrecourse, the debt is only secured by the property, and you are not personally liable for the balance. In California, most mortgages to purchase homes are nonrecourse, but mortgages from refinances are typically recourse. This is important, because they are taxed differently. If it is a nonrecourse debt, you simply treat the debt forgiven as your sales price, subtract your tax basis (your cost less any depreciation taken) and the difference is your capital gain. If it is a personal residence, you may qualify for up to a $250,000 ($500,000 if jointly held)exclusion on that gain. If it is recourse, the debt is satisfied only up to the fair market value of the property – which is the amount you use to determine your capital gain. But if the lender forgives a recourse debt and it exceed the fair market value of the property, that is “cancellation of indebtedness “ ordinary income. This income may also be excluded from gain if it is “qualified principal residence” indebtedness. The point is that you need to know the tax consequences of a short sale before completing the transaction – to that end, we may be able to find you a good accountant to assist you in doing your due diligence.
