A borrower can make debt settlement with the lender for a lesser amount than the total amount due. Thereby the former might have to report this debt which has been forgiven as regular income along with some exceptions. The categories which fall under forgiven debt are money due after foreclosure or repossession of property or unpaid credit accounts. The exceptions are:
o The lender exempts an amount which is more than the principal amount of the debt. A 1099-C form has to be delivered to the borrower at the year end. According to the IRS the written off debt amount has to be reported as income while filing tax return by the borrower.
In case of non delivery of the form to the borrower it is assumed to have directly forwarded to IRS by the lender. If the borrower does not report the exempted debt amount as income, there can be serious consequences. One can receive a tax bill or an audit notice if IRS is aware of the transaction on their database.
o Circumstances where the forgiven amount of debt was treated as a gift, one is not required to report the same as income.
o The borrower faces bankruptcy and discharges the debt.
o Borrower’s insolvency before the creditor’s settlement of debt is considered.
Consultation is suggested from a qualified tax and legal counsel to check whether it is possible to avail the benefits from these exceptions.
The debt amount which a borrower escapes is sometimes referred to as phantom income. Often a lender makes a probe to judge the truthfulness of the status of the borrower. This is referred to as deficiency judgment which is the difference between the total amount due and the amount paid out of short sale. Henceforth the burden on the borrower increases further. He loses the property, earns nil from the transaction and can suffer from possible insolvency. This can result in a permanent setback for the borrower.
So there has been a solution to this problem. A new federal legislation has been formulated comprising of a temporary three years moratorium. It relates to the tax treatment of the exempted debt that does not exceed the basis of the owner in the home.
The lender in a short sale makes some verification regarding the estimated closing costs on HUD-1 form used by the settlement agent. The cost includes the taxes, real estate commissions, homeowner dues, title insurance costs and other closing costs. Approval of the said form by the lender is necessary for the closing of the short sale transaction.
The short sale tax implications has been formulated and reviewed continuously to suit both the lenders and the borrowers.
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Short Sale Tax Implications…what implications? All you need to know about Short Sales and tax considerations at http://www.nphsrealestate.org/short-sale/law-tax
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