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Tax Consequences of a Short Sale of Your Principal Residence

Real estate has reached a saturation point and it is predicted to experience a downward curve. Morgan Stanley is anticipating a fall of 10% in real estate prices by the end of 2024  or more. Homeowners who have purchased at a higher price are sure to experience trouble if the US falls into a recession. Foreclosures can only lead to disaster with the smashing of credit ratings. Do not panic, there is always an alternative if you have trouble with mortgage payments. It is called a short sale. One good thing about a short sale is it prevents foreclosure but it can result in tax liabilities.

Define Short Sale

It can prevent foreclosure especially when their home is only worth less than the loan amount. The lender can sell the home at a regular price with the help of real estate agents for an amount lower than the mortgage. The lender takes the proceeds from the sales and releases the mortgage lien and writes off the balance loan as uncollectible debt. The lender is happy to accept the offer because, the home is less than the homeowner owes and also because the homeowner is unable to meet the mortgage payments due to personal issues like health issues, job loss, death, etc.

Types of loans

In a Re-course loan, the borrower is liable for the debt. On the contrary, in a non-recourse loan, the borrower is not liable. In case of a default, the lender acquires the collateral property for the loan, and the borrower’s assets are not collected.

In a non-recourse loan, if the lender forgives a loan post-short sale, the income is not taxable to the borrower.12 states allow non-recourse home loans. In recourse, a home loan is allowed in 38 states. In a non-recourse loan, forgiven debt is taxable unless the following two exceptions are seen.

1. Qualified principal residence indebtedness exclusion

2. Insolvency exclusion

In a short sale, the homeowner can avoid bankruptcy. However, it can reduce the credit rating of the homeowner. 

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