Short Sales of Real Estate When you sell real property in a Short Sale Transaction there are numerous tax implications that you will want to consider. First, just what is a Short Sale. A short sale is when you sell a property and the sales proceeds are not sufficient to pay off the loan that you have on the property and you ask the lender to accept less than the full amount they are due to pay off the loan. When you short sale a property the tax considerations revolve around two basic issues. First, the income from the cancellation of the debt, and next any gain that may have to be recognized on the sale. Cancellation of debt income occurs when you pay less than the full amount back to the lender. When you borrowed the money from the lender you did not have to pay tax on the borrowed money because you were obligated to pay back the debt. However, when the debt was canceled and you did not have to pay it back that is income. The lender will send you a 1099C informing you and the IRS of the canceled debt. You will also have to determine if there is a gain on the property you disposed of in the transaction. The IRS considers this disposition a sale and you must report the sale less the tax basis in the property. This could result in a gain if you have a low basis in the property and refinanced it pulling out cash. The next thing that you need to consider is whether the income from the Cancellation of the Debt is actually taxable. There are four exclusions that must be considered. First, if the debt is non-recourse (as determined by state law) there can be no income from the cancellation of the debt; Second, if the home was your principal residence the debt is excluded up to $2,000,000 by the Mortgage Forgiveness Debt Relief Act of 2007; Third, if you are insolvent the cancellation of debt is forgiven to the extent that you are insolvent at the time the debt is forgiven; Fourth and finally, if you are bankrupt the cancellation of debt is forgiven if it was included in your petition. The cancellation of debt and how you handled it for tax purposes is reported on Form 982 that is included with the filing of your form 1040. This is where you also adjust the basis for assets where debt was canceled.