Will cancelled short sale debt be taxable income?

August 10, 2011

From:  Rhiannon
Date:  30 Sep 2009

I am considering short selling a rental house located in California.

I bought it for $145,000 as a private residence in 2001. Then I got married and moved into my wife’s house and we rented my house out.

Since then, I refinanced the house for a total of about $240,000 of debt with an interest-only payment. The rent doesn’t cover the monthly payments. Only about $3,000 of the money received from refinancing the mortgage was used to fix up the house.

The house is now worth about $150,000 to $170,000.

If the unpaid balance of the mortgage is cancelled in a short sale, will the cancelled debt be taxable income?

Answer

Date:  19 Oct 2009

Hello Rhiannon,

Possibly. Remember there are other ways to qualify for an exclusion of cancelled debt, including insolvency and bankruptcy. See my article on short sales and foreclosures at www.realestateinvestingtax.com/shortsale.shtml and IRS Publication 4681 at www.irs.gov.

If you don’t qualify for an exclusion, the income will be taxable.

Remember to consult with a real estate attorney to be sure the debt will in fact be cancelled after the short sale.

Good luck!
Mike Gray

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