A “short sale” occurs when a mortgage lender allows a Seller to sell their property for less than the balance owed on any outstanding mortgage(s). Most lenders waive their right to pursue the short fall and cancel or forgive the debt owed by the Seller. Lenders then report the difference between the balance owed on the mortgage(s) and the current market value of the property to the IRS by issuing the property owner a 1099 at the end of the year.
As a result of the enactment of the Mortgage Forgiveness Debt Relief Act of 2007, the forgiven or cancelled debt may be excluded from Seller’s income if the forgiven debt was used to buy, build, or substantially improve the Seller’s principal residence. Debt forgiven that does not qualify for relief under this Act includes second homes, rental property, business property, credit cards, or car loans. For more information, see http://www.irs.gov/individuals/article/0,,id=179414,00.html. The Mortgage Forgiveness Debt Relief Act of 2007 also expires on December 31, 2012. If your short sale does not close by the end of this year, you may be responsible to include the forgiven debt as income on your taxes.
** You should also contact your tax advisor or accountant to determine whether your principal residence debt is excludable as income. **