Tax Implications of Debt Forgiveness

This post is in: Business

As the real estate values have plummeted, a lot of Americans are in upside down real estate and some simply can’t hang on any longer. You might be in the same spot – looking at foreclosure, considering a short sale or exploring a loan modification. I’ve had clients successfully renegotiate their loans, actually for some pretty amazing amounts (as much as $200,000 in debt reduction and 3% with a 40 year amortization).

If you’re looking at any of these options, get as many facts as possible first. Please go to HomeMortgageLoanModifications]( to get more information before you act.

One of the things to consider in any of these is what happens to the excess debt. For example, if you have a loan on your property of $400,000 and it’s only worth $250,000 now and the company either allows a short sale or a principal reduction to that amount, there is $150,000 still to figure out what to do with. In some cases, the company isn’t allowed to come after you for the debt. (That’s called getting a deficiency judgment.) In many cases, though, people thing they’re exempted and they’re not. In fact, under most state law the lender has up to 4 years to file against you.

If instead, they forgive the debt (which is most likely what you are hoping for), you have a taxable event. If it was your principal residence and the debt is only acquisition indebtedness you will get a pass. Otherwise, it’s taxable.

If you’ve had a foreclosure, deed in lieu of foreclosure, short sale or loan modification, don’t forget possible tax implications. There is a way around it – a Form 982 filing with your tax return – but you must file it with your return!


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  2. christopher bell says:

    Will writing a letter of forbearance, to the first and 2nd mortgage holders, (to set up agreement to avoid short sale or foreclosure), mess up filing Form 982 if no forbearance agreement is reached?