Questions on foreclosure or short sale

I used to get a lot of questions on foreclosure at the office. Oftentimes, the callers or clients were surprised to find out they may have a big income tax bill when they've lost their home or rental property. If you are interested in this subject, I'd like to point you to the following IRS article: http://www.irs.gov/newsroom/article/0,,id=174034,00.html

Q) How is your situation different if you have refinanced your residence?

A) There is no taxable income from the cancellation of debt for the original mortgage. However, refinancing changed the loan from the original non-recourse loan (not personally liable) to a personally liable recourse loan, then you might have taxable income from the cancellation of debt.

Q) What are the tax consequences from foreclosure or short sale?

There are two tax consequences:

1) The cancellation of debt may be treated as ordinary income. 2) Since the foreclosure is treated as a sale, you might realize a gain or loss. It is possible for someone to lose their property in a foreclosure and end up having to pay capital gains tax. The capital gain amount are calculated differently based on the loan type.
                              

Q) Will filing for bankruptcy help?

A) Yes, if the debt is approved by the court, the cancellation of debt is not considered as taxable income.

Q) How is the tax situation for rental property different?

A) Under the Mortgage Forgiveness Debt Relief Act of 2007, you don't have to pay federal income tax on up to $2 million of debt secured by your home. This tax relief does not cover rental properties. It only applies to forgiveness from 2007 to 2012.