Taxes After a Short Sale: The Questions to Take to a CPA

This article will not tell you what you owe. That is not modesty. It is the only responsible position, because the tax treatment of a short sale turns on facts about your loan, your property, your basis and your return that nobody can assess without reading them.

What an article can do is tell you that the question exists, that it is one of the biggest financial variables in the whole transaction, and what to walk into a CPA's office holding.

Free help, and the fee rule

A HUD-approved housing counselor should still be your first call for the sale itself. Counseling is free and unconflicted, and a counselor will tell you the same thing said here: the tax question goes to a tax professional.

NOBODY SHOULD CHARGE YOU AN UPFRONT FEE to negotiate a short sale or to promise a particular tax result. A tax professional charges for their work, which is a normal professional fee for services rendered, and that is a different thing entirely from an advance-fee rescue offer. If somebody is bundling a guaranteed tax outcome into a sales pitch about saving your home, that is your cue to leave.

Why forgiven debt raises a tax question at all

In broad terms, when a lender agrees to accept less than the full balance and releases the remainder, an amount has been forgiven. Forgiven debt is a category the tax system has rules about, and the servicer may report the event to the IRS and to you on an information return.

There are also potentially two separate questions rather than one. There is the treatment of the forgiven amount. And there is the treatment of the disposition of the property itself, which is its own calculation and which is not the same conversation.

Both federal and California rules matter, and they have not always aligned. Provisions relevant to mortgage debt have been enacted, extended, allowed to lapse and revised at different times over the years, which is exactly why a general summary is dangerous. What was true for a neighbor in an earlier year may not be true for you now.

The questions to bring

Take these, in writing, and let the professional answer them against your documents.

How will the forgiven amount be characterized in my situation. Is any exclusion or exception potentially available to me, and what would I have to establish to rely on it. Does it matter whether this was my principal residence. Does it matter that the loan was refinanced, or that cash was taken out at some point. How does the disposition of the property itself get reported, separately from the forgiveness. Does California treat this the same way the federal rules do. What should I do when the information return arrives, and what do I do if I believe the figure on it is wrong. And what records do I need to keep, for how long.

That last one is not filler. The documentation you keep now is what supports whatever position is taken later.

What to bring with you

The approval letter with every condition. The closing statement. The original loan documents and any refinance documents. The information return if it has arrived. Your prior returns. Evidence of what the property cost you and what you put into it. And, if the property was ever a rental, the depreciation history, which changes the analysis in ways owner-occupants never encounter.

That last point is a whole category of its own, covered in how a Claremont short sale differs on rentals and second homes.

Ask before you sign, not after

The most valuable timing here is early. Once an approval is accepted and a sale closes, the facts are fixed and the tax analysis is about what already happened.

Ask the question while the deal is still being shaped. It occasionally changes what you negotiate for, and it always changes how prepared you are. The terms themselves are a separate professional question: a real estate attorney should review any condition affecting your liability, including any promissory note offered in place of a clean release, and California's statutory provisions on deficiencies after a lender consents to a short sale, including those enacted in Senate Bill 458, are for counsel to apply to your loan rather than for you to apply from a summary. Verify current law with an attorney.

Do not guess from someone elses outcome

This subject attracts confident secondhand advice more than almost any other part of a short sale. A relative who went through one, a forum thread, a neighbor who remembers what their accountant said. All of it describes a different set of facts in a different year under rules that may since have changed.

Treat every such account as a prompt to ask your own professional the same question, not as an answer. The cost of a consultation is small next to the cost of planning around a result that was never going to apply to you.

Do not let the tax question decide the sale by itself

It is one input. Reinstatement, a repayment plan, a loan modification, or an ordinary sale if there is equity may each be a better outcome overall, and the comparison in short sale versus foreclosure is worth making with a professional's read on the tax side alongside it.

Nobody can promise you an approval, a timeline, a deficiency outcome or a tax result. What you can have is the right question asked of the right person, early enough to matter.

For the full set of options, start at the Claremont short sales guide.

Anthony Grynchal has been licensed in California since November 2009.