Overhaulin'

The taxes on a short sale of a home? Do sellers not have to pay any?

One of my "friends" was in a house that they were about 80K upside down in. They moved out and put it up for rent. They got renters in there and had them sign a lease that was backdated six months. The renters were just happy to get in and went along because my "friend" told them that it needed to say that so they could qualify for a new house. So the renters move in, are there for two months. In the two months they were approved for their new house witch is a bigger house in a brand new development and the cost is only $5k more than they owe on their much smaller, older home. They went through escrow and moved in. A week after they move in, they send a letter to the renters and tell them that they have to move out because they are "short selling the house". The renters were irate and all kinds of drama happened. Renters are out less than a month later...furious and pissed off. They do not get their deposit back because they are charged all kinds of BS fees by these people. Move forward, the house DID short sell for $60K less than owed on it. HUD actually bought the house. Now my question. These people pulled an OBVIOUS scam and make no bones about the fact that they do not feel bad about it and call it "a good business decision" on their end. Do these people get off Scot Free from the taxes? I would think they should be taxed on the difference of the amount owed and the short sale price. I would think that would be what happenes, but one of my other friends says NO, that nowadays due to so many of houses getting foreclosed on and short saled, they dont have to pay the taxes on the difference. I am just appaled that people get away with this. When I bought my car and drove off the lot, it lost 30% of its value right then and there, I cannot stop making the payments and just go get a new one. I just dont get it. So, do these people have to pay the taxes or do they totally get away with scamming the system. It was a rental. They closed on their "new" house 10/31/09 and the short sale date of the "old" house is 10/26/10. I am sure they lied their way out of it though. It just disgusts me that people so proudly get away with this and the rest of us who are living up to our responsibilities even though they did not pan out to be the best choices are still paying our bills, upside down or not.

Public Comments

1. Dear LV: Great question and I don't think you will like the answer. Somewhat complicated but the people who short-sold will probably get away with owing a penny. The mortgage company or bank will probably issue a 1099-C (eventually) and the owners will be able to exclude the cnx of debt if they have lived in the home as their primary residence. Now the rental aspect might be a complication if it is revealed they rented the property. If this was a business venture they may not be able to claim the home as their primary residence. The rental money is income and must be reported and the address of the rental property will be listed so it could come crashing down. The rules are IRS rules and we do not always agree with them and a lot of mis-application of these rules has been documented by the IRS. This advice was prepared based on our understanding of the tax law in effect at the time it was written as it applies to the facts that you provided. Click on my profile to read more. Errol Quinn Enrolled Agent
2. They will receive a 1099 for the 60K. They have committed mortgage fraud as well.
3. They may get away with it but what they did was fraud. If you have a short sale or foreclosure on your primary residence and it was never refinanced then you are protected. You are not protected on a rental.
4. Having moved out to a new home before losing the old one, they changed their principal residence and aren't legally eligible for the mortgage debt relief act. The problem of course is that an audit would be necessary.
5. They must pay taxes on the difference. The recent development that lets other short sellers, but not these particular ones, avoid taxation applies only when the seller is insolvent. Since they had the money to make a downpayment on a house that closed 5 days later, they were not insolvent, and must pay the tax.