Foreclosure Short Sale Consequences

Many people go for short sales or let their lenders foreclose so they can get rid of a heavy mortgage and start off on a clean slate. But after the sale, many are caught off guard by the consequences of foreclosure and short sale in terms of taxes, credit, and other vital aspects. If you’re thinking of letting your home go, make sure to take into account both foreclosure and short sale consequences—and how they can affect you later on. Here’s a quick guide to help you get started.

Why Do You Get Taxed?

Foreclosure tax consequences are perhaps the most common surprise for troubled homeowners. Short sales and foreclosures can both result in two types of income: capital gains and relief of indebtedness. Depending on the bank, these may not always come up as short sale consequences, but they often do in a foreclosure. The government may tax you for the amount your lender has forgiven, and for any profit made from the sale.

What’s The Difference?

Both foreclosure and short sale consequences are calculated separately. If your lender accepts a discounted payoff on your mortgage, the difference is usually considered debt relief and is taxed as ordinary income. Any profit made from the sale will be considered a capital gain and taxed accordingly. Likewise, as is the case with most foreclosures and short sales, losses will be taken into account and subtracted from the taxable income.

Protective Laws

To help protect borrowers from home foreclosure consequences, the government signed a bill in 2007 lifting the tax on short sales and foreclosures. The Mortgage Forgiveness Debt Relief Act of 2007 will be in effect until 2012, and will protect homeowners from foreclosure tax consequences for gains of up to $2 million.

Other Consequences

After a foreclosure, lenders often demand deficiency settlements in addition to foreclosure tax consequences. This refers to the difference between the mortgage balance and the home’s selling price, and is meant to account for the loss incurred by the lender. Deficiency charges aren’t as common as short sale consequences, but may also be charged depending on the lender’s policies.