by Calculated Risk on 3/25/2007 03:41:00 PM

From the LA Times: 'Short sale' brought them relief -- which IRS is going to tax

Question: I understand that a "short sale" means the mortgage lender agrees to accept as payment in full a sale for a home's market value even if it is below the mortgage balance. ... The lender agreed to accept a short sale for $183,785 though our mortgage balance was $210,000. But we received IRS Form 1099 from the lender showing we had taxable "debt-relief" income of $26,215. How can we be taxed on money we didn't receive?

Answer: As an alternative to foreclosure when a mortgage borrower stops making payments, some lenders will accept a "short sale" of the property for less than the mortgage balance. ...

However, the IRS says debt relief is taxable. ...

I believe this is also true when a homeowner resorts to jingle mail. A common scenario might be a homeowner who refinanced their home with cash out, and then discovers they can no longer make the payments, and that they have no equity in their homes. If the homeowner then just mails the keys to the lender - jingle mail - I believe the homeowner will receive a tax bill for the difference between what what the house sells for in foreclosure and what they owed. I also believe the lender might pursue the homeowner for any losses (the 2005 Bankruptcy Law made it more difficult for homeowners to declare Chapter 7 bankruptcy).

UPDATE: In the comments, attorney Bill McLeod writes:

... there are some new forms and new requirements, and I have to make my clients gather far more documents than I ever had to before BAPCPA became law, but a struggling homeowner can still file Chapter 7 if this [is] the option they are considering.

Anyone in this difficult situation should consult with an attorney and tax advisor.