In a short sale, a homeowner sells their home for less than they owe, and the mortgage holders agree to forgive some or all of the debt secured by the property. Until 2007, a homeowner who liquidated her home through a short sale was charged income tax on the forgiven debt. Talk about kicking you while you’re down — you’re so broke you can’t stay in your home; you are so upside down that you have to sell it at a loss; and then you’d have to pay taxes on the loss, too?! I’ve actually seen sellers choose to allow their home to be foreclosed on rather than incur the tax obligations that used to be incurred as a result of a short sale.
This law temporarily eliminates the income tax obligation on short sale-related mortgage debt that was forgiven by a mortgage lender, making it less burdensome for a seller to get rid of their home through a short sale. For a homeowner who owes more than their home is worth and needs to try to sell it short, this law makes it worth your while to try to avoid foreclosure through a short sale, without fearing any tax penalty. Note — this act is also temporary, providing an exemption from the income tax on mortgage debt that is forgiven only through the end of 2009.