USDA short sale deal falling apart, NEED HELP !?!?? SOS

[Kris Haskins]

Hey BP Fam, I have an approved short sale with USDA, the letter states they will accept my offer and it has the net amount on the letter.  The seller is worried the IRS will count the difference between the sales price($80k) and the total loan amount($120k) as ordinary income (approx $40k) and is ready to walk from the deal.  The seller's attorney is advising NOT to sell the house and let it go to foreclosure.  Is there any way I can save this deal, SOS!?!????   

[Denise Evans]

The lender MUST issue a 1099C for cancellation of indebtedness. That is the law. It is not negotiable. It would be similar to asking your employer to not W2 you. That being said, the debt forgiveness will not be taxable if the borrower was insolvent immediately before and after the short sale. That means total current FMV of all assets, and total full balance of all liabilities, net against each other results in negative number or $0. Retirement accounts must be included in the assets, unfortunately. But, most people's personal possessions are worth FAR less than they think. Liabilities includes everything--credit cards, car loans, car lease obligations to end of the term, child support until child reaches age of majority, tax liabilities, loans from relatives, student loans, everything. Virtually everyone in a short sale is insolvent.

For the year of the short sale, when that tax return is due, the borrower will also file IRS Form 982. For the insolvent before and after reason, they check box 1b.  The 1099C is not reported on the 1040.  From 982 explains to the IRS why they received a 1099C but do not see that income of the tax return. We say it is "excluded" from income.  

Form 982 is an audit flag, but not everybody gets audited. If the borrower gets an audit letter, it will simply ask how they arrived at the asset and liability values. A simple list of "before" assets and "after" assets in general categories (household goods, vehicles, cash, retirement accounts, real estate, collections) and itemized liabilities is usually sufficient. If the borrower is honest about the values, he has nothing to fear. It is not necessary to get appraisals, but some sort of printed market research would help. Saying someone's household goods are worth around $1,000 is usually safe.  Sometimes even $500 is sufficient. We're talking garage sale prices here.

The borrower should not stress about getting everything absolutely accurate. There is no such thing.  Just do the best he can, but it's okay to be conservative and estimate on the low side of the market.

Even if the cancellation of indebtedness results in a positive net worth, taxes are due only on the positive portion. In other words, if the borrower has $100,000 of debt forgiveness, and afterwards has a positive net worth of $5,000, he pays taxes on only the $5,000.

Finally, House Resolution 110 in Congress seeks to amend the Home Mortgage Debt Forgiveness Act and make it permanent. It expired on December 31, 2016.  If made permanent, then up to $1 million of debt forgiveness on a principal residence for single people, up to $2 million for married people, will be tax free. If that law passes, then the borrower would check box 1e on Form 982. A qualified principal residence means a property used as the borrower's principal residence for 24 of the prior 60 months. The 24 months do not have to be contiguous. It can be separate occupancies, as long as they all add up to 24 months.  You should monitor the progress of this resolution.

I hope this persuades the borrower to move forward.  Good luck, and let us know how it turns out.  Be sure to mention my name in your "how it turned out" report, so I'll get a notice.