Is it true that the IRS can tax you on the difference betwee your mortgage amount and the final short sale elling price. $200K mortgage, $100k short sale, IRS taxes that $100K difference

It depends, but for most taxpayers in 2012 this is not the case. It depends on whether the house was your principle residence - if it was, then the difference between the outstanding loan amount and the short sale amount is not taxable to you. This is because the Mortgage Foregiveness Debt Relief Act of 2007 which gives a brake to homeowners losing their house through foreclosure. But this act expires at the end of 2012, so if you don't close on the short sale in the next 2 weeks then yes - the difference would be considered taxable in 2013. There is a bill in congress to extend the provision past 2012 but so far there has been very little movement on it (not a surprise if you're watching the fiscal cliff negotiations).

Also - if you declare insolvency prior to the foreclosure then it's not taxable.

Also - if you declare insolvency prior to the forclosure then it's not taxable.


How does one "declare insolvency"? You mean bankruptcy?

How does one "declare insolvency"? You mean bankruptcy?

The IRS makes a distinction between the two. Bankruptcy is a court action such as Title 11 Chapter 7. Declaring insolvency to the IRS is simply a matter of filing Form 982 with your tax return to show that your liabilities exceed your assets. See IRS Pub 4681, "Canceled Debts, Foreclosures, Repossessions and Abandonments." Page 4 discusses how to declare insolvency.

http://www.irs.gov/file_source/pub/irs-pdf/p4681.pdf