Foreclosures and Short Sales, A Ticking Tax Time-Bomb for Panhandle

Written by Peter Tran

July 1, 2017

The number of foreclosures, short sales, and property owners smply handng over ther keys remans at an all-tme hgh.  Unfortunately, ths trend wll contnue for the foreseeable future – as as the number of owners “underwater” remans at an all-tme hgh.

Accordng to the Census Bureau, approxmately 40% of all homes (dwellng unts) n Berkeley and Jefferson County were bult between 2000 and 2010.  The majorty of those who purchased these homes have mortgages that exceed ther home’s value.  ndvduals who refnanced or obtaned secured equty lnes durng the “bubble,” are n the same boat – ownng propertes submerged n debt – or as we have come to say – “underwater”. 

The trauma of losng a property to foreclosure or short sale can be overstated.  After months, often , of struggle owners fnally abanns the dream of ownershp.  Emotonally detached from the property, they smply want to move on wth ther lves.  The last thng they need s more bad news.

More Bad News – A Tax Bll – the Tckng Tax Tme-Bomb:  n too many cases ths emotonal detachment, combned wth erroneous tax-, false assumptons, and flat-out msnformaton, s creatng a secondary crss for beleaguered homeowners – a ggantc, computer-generated tax bll that arrves two or three wn the road.  The cause: under or msreportng “ncome” generated by the short sale, foreclosure or abannment.  Ths column wll brefly dscuss: 1) How ths ncome s generated, and 2) Why msreportng or under-reportng starts the countwn to possbly recevng a gant, unexpected tax bll.

“…But ’m Broke!”  One of the most common questons we receve regardng ths topc s “How can have taxable ncome when ’m broke?”  Unfortunately, the answer s relatvely smple.  Here are two common, mathematcally smplfed, scenaros:

n both stuatons, John and Joan receved the use and beneft of money they dd pay back.  When the bank forgves a debt for whch an ndvdual s personally lable t generates what s called Cancellaton of Debt ncome.  The bank s requred to report Cancellaton of Debt ncome to the RS and the taxpayer by submttng Form 1099-C.  f the taxpayer es properly report ths ncome, RS computers wll automatcally “correct” ther return and send them a bll for the tax due, plus penaltes, plus nterest.  t generally takes 8 to 15 months after the bank reports the canceled debt for the RS to catch up to the taxpayer wth a bll. 

There are ly fve possble exclusons of Cancellaton of Debt ncome: 1) Debt Dscharged n Bankruptcy, 2) , 3) Qualfed Farm ndebtedness, 4) Qualfed Busness Property ndebtedness, and 5) Qualfed Personal Resdence ndebtedness (scheduled to expre at the end of 2012 f extended by Congress).  These exclusons, however, are much more restrctve than ther ttles suggest and requre tax expertse to properly apply.

So, f you or someone you know s consderng short sale, facng foreclosure or thnkng of abannng a property, obtan Tax Professonal assstance BEFORE actng.  Also, have an experenced tax professonal prepare ths year’s return.  t can save you thousands.  f you have any questons or need assstance, please feel free to contact our offce at 304-267-2594 to speak wth a tax professonal.

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