The tax problems are for the borrower, not for you.
The IRS says that if someone owes money and the creditor forgives that debt, it is the same as earning income in the amount of the debt forgiven.
Suppose a borrower owes $120,000 on her home. Facing foreclosure, she agrees to sell it to you for $100,000. The lender agrees to accept only $100,000 and to forgive the remaining $20,000. According to the IRS, the borrower will have a taxable income of $20,000.
The Mortgage Relief Cancellation Act of 2007 proposes to change this rule, at least in the context of foreclosures and sales made to avoid foreclosure.
While it was introduced in April 2007, the law has not moved out of committee. Until it gets passed into law, you may want to remember the simple loophole. It may be necessary to explain the loophole in order to gain borrower’s assistance for a short sale.
Simply said, the IRS states that there will be no taxable income if the borrower was insolvent before the debt forgiveness and he or she was still insolvent after the debt forgiveness, in other words, his or her debts were greater than his or her assets. The borrower may need to keep records regarding his or her insolvency in case there is an audit in the future.
If you are interested in this subject, read IRS Publication 908, “Bankruptcy Tax Guide,” available at your post office, local IRS office, or online at www.irs.gov. The advice in this form is not limited to bankruptcy situations.
