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Tax implications of a Short Sale

Naples, FL |

Please explain possible tax implications of a short sale of real estate

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Attorney answers 3


Also, if the property is investment property, and you have been depreciating it on your tax returns, the IRS will recapture that amount you have taken over the years.


See IRS Pub 4681 for good info and examples:


A short sale under the amount of debt on the property triggers tax liability for cancellation of indebtedness under both federal and state tax laws. After a short sale, should the lender(s) forgive the debt in excess of the "sale price" (instead of pursuing you for the deficiency balance), you will likely trigger income to the extent of debt forgiven and the lender will issue a Form 1099-C to that effect. You need to determine whether your debt is nonrecourse (you are not personally liable) or recourse (you are personally liable) because different analyses apply (i.e., Gain/Loss and Cancellation of Debt Income). Note: cancellation of debt income is taxed as ordinary income.

If the property is a principal residence subject to recourse debt, then I.R.C. section 108 federal exclusions for gain from the sale and discharge of acquisitional indebtedness would be applicable to transactions through 2012. You need to check for applicable exclusions in your state. It's important to note that cash taken out of the property value not used to improve the property is generally not qualified for exclusion and is taxable.

If the property can no longer be classified as a principal residence, other exclusions may be applicable including qualified real property business, insolvency or bankruptcy.

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The information in this answer is for general information purposes only. Nothing on this communication should be taken as legal advice for any case or situation. Nothing herein is intended as legal advice. You should not rely upon any information as a source of legal advice, and your receipt or viewing of any such information does not create an attorney-client relationship between you and James E. Pratt.

IRS Circular 230 Disclosure: To comply with requirements imposed by the IRS, we inform you that any U. S. federal tax advice contained herein (including any attachments), unless specifically stated otherwise, is not intended or written to be used, and cannot be used, for the purposes of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter herein.

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