I've been asked a lot more lately about whether a seller has a cancellation of debt tax liability after a short sale if the property is the one you lived in - your primary residence.
A few pieces of demystification.
Sellers take the full loan balance and subtract the sales price. In a short sale, this is a positive number (or zero) and is treated as ordinary income.
But - the Mortgage Forgiveness Debt Relief Act of 2007 requires that the seller not be taxed on this income for federal income tax purposes (note, not necessarily state) if the following conditions are met:
1. You lived in the home - primary/principal residence
2. the loan was used to buy, construct or improve that home referenced in #1
3. the income not taxed is capped at $1 million for a married person filing separate and $2 million otherwise;
4. the short sale has to take place after Jan 1, 2007 and before January 1, 2013 (any guess as to how long the government thought this might be an issue? Hmm...)
A reduction of debt tax savings is applied to reduce the basis of the property though which could increase your capital gains tax owed.
Want to know what else qualifies? Check this out:
http://homebuying.about.com/gi/o.htm?zi=1/XJ&zTi=1&sdn=homebuying&cdn=homegarden&tm=28&f=10&tt=13&bt=0&bts=0&zu=http%3A//www.irs.gov/individuals/article/0%2C%2Cid%3D179414%2C00.html
California residents? Beware. Cali tax law says that while a lender may have a legal right to go after assets (they usually won't) some states limit their ability to obtain deficiency judgments. In California, according to the California Association of REALTORS, a deficiency judgment may be filed regarding a hard-money loan if the lender forecloses under a judicial foreclosure versus a trustee sale or if the second loan is a hard money loan and the sale takes place as a trustee's sale. This means that if you took a home equity line out and your home is in foreclosure, the lender may try to sue you (though they usually don't).
How does all of this affect credit? Im asked that a lot too so did some homework tonight.
Short sales: You aren't asked about them on applications. All lenders report short sales differently and some do not report them to the credit bureaus at all. A short sale is not a derogatory mark on your credit because credit bureaus do not show the word "short sale" on your credit. It may say "pay as agreed" or "paid as less than agreed". Some report negative FICO score drops from 50 points to 130 points. If your payments have never fallen behind 30 days late and the lender does not require that you pay back the loan, Fannie Mae guidelines may allow you to buy another home immediately. The wait time for an FHA loan is 3 years. If your credit report does not reflect a 60-day+ late pay, under Fannie Mae guidelines, you will be eligible to buy another home immediately.
If your payments are in arrears yet a short sale is granted by your lender, you may qualify to buy another home with a Fannie-Mae backed mortgage within two years, regardless of whether the home is your primary residence.
The point drop is typically due to being in default, that is behind on your payments.
Foreclosures: You are asked about them on applications referring to the past 7 years. You may be denied a job if a company runs credit. Reports of FICO score drops from 200 to 400 points after a foreclosure. Generally this credit score will remain on your credit report as a public record for 10 years. If you want to buy again, you may be eligible to buy another home in 5 years if the home was your primary residence. Otherwise it's often 7 if you need the FHA.
If you are an investor and do not occupy the home, the wait to buy with a Fannie Mae insured loan is 7 years.
If you are in foreclosure and have had a judgment filed, a short sale may put that off for 2-3 months while the bank considers it.
There.. clear as mud? :)
Dani
