(As you might recall mortgage is from two Latin rules “mort” meaning death and “gage” meaning grip.)
With all the mortgage troubles that folks are experiencing, some folks view a “short sale” as a way to get out from under their debt. However, you might be in for a surprise. The portion that the bank looses in the transaction might be considered taxable income to you by our friends in the Eternal Revenue Service. Yeah, you could be the astonished recipient of a Form 1099C from your lender.
There are IRS tax rules in place for when lenders are forced to foreclose because home owners have become delinquent in their mortgage payments. You will owe taxes on the difference between what the lender gets for the home and the outstanding mortgage loan balance. The same is true for a mortgage short sale. You will owe taxes on the amount of your loan or mortgage that the bank or lender has forgiven. That’s right, you are taxed even when you don’t receive any actual money.
IRS instruction for Form 1099C
If a federal government agency, certain agencies connected with the Federal Government, financial institution, credit union, or an organization having a significant trade or business of lending money (such as a finance or credit card company) cancels or forgives a debt you owe of $600 or more, this form must be provided to you. Generally, if you are an individual, you must include all canceled amounts, even if less than $600, on the “Other income” line of Form 1040.
Remember, the first rule of holes is stop digging. See a tax professional before you go down this path.