I am in the process of preparing my income taxes, and heard that I may have to pay a tax on the moneys that my lender canceled when I sold my house via a short sale after I divorced my spouse. Is this truet?
It depends. Usually under the tax laws, if your debt is canceled or forgiven, that is taxable income to you.
However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million, if that debt was on your principal residence.
If the debt was on a second home or an investment property, then you are out of luck; the amount that was forgiven (or canceled) is taxable income to you.
What would you be taxed on? If you owe $500,000 on a home and it is sold for $400,000, then you would owe tax on $100,000. BIG TAX BILL!!!
If your canceled debt was on a refinanced loan, the law is tricky. If you used the refinance proceeds to substantially improve your house, then there is no tax to pay. But if you used those proceeds for other purposes (pay off credit cards, get a loan to buy a car, vacation etc.), regardless of how significant the investment may have been, the cancellation creates a taxable event for you.
The IRS has an excellent, free, publication on this topic, called "Canceled Debts, Foreclosures, Repossessions and Abandonments." It is Publication 4681, and will soon be published at the following link on the IRS website -- http://www.irs.gov/pub/irs-pdf/p4681.pdf -- or by calling (800) 829-3676, or (800) TAX-FORM.
Andre Luc Plessis
REALTOR®, RCS-DTM REALTOR® & Financial Educator
Keller Williams® Realty
The Wealth Creation Team
Empowering People to Buy & Sell Real Estate Correctly!
CA DRE License # 01856185
Tel: (818) 341-2972
Cell: (310) 266-9463
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