Poor Ms. Lawyer… I’ve really been picking on her a lot lately, I know.
Well, I’m sorry but this whole experience of responding to her letter has been too good of a learning opportunity for my readers — I couldn’t pass it up! (For those of you who haven’t been following along, go here to read the full text of a letter I received from an attorney advising her client against doing a Short Sale with an investor.)
So anyway, here’s Part 9, where we get into a common misconception about Short Sales and taxes. (We’ll definitely be getting even further into this same topic at Short Sale Breakthrough 09 in Orlando on July 27-29.)
First the excerpt from the lawyer’s letter, then my response:
Additionally, there is an income tax concern that these transactions raise. If the transaction is successful and your debt is forgiven, you will be assessed debt forgiveness income on the difference between $700,000 and the amount outstanding on the note. The higher the purchase price the better for you. It is not wise to restrict your ability to obtain higher prices.
You are correct that there is an income tax issue. However, you may be completely wrong to suggest that if the debt is forgiven that your client will be assessed debt forgiveness income. If the property is the seller’s primary residence, debt forgiveness income will not be considered taxable income up to the amount of the purchase money mortgage. However, Ms. Attorney, the biggest omission here is that it’s likely your client would face the same tax issue if the seller does not pursue a Short Sale and instead enters a deed in lieu or allows the property to go to foreclosure.
Even if the difference between the Short Sale payoff and the debt is considered taxable income, the seller may not “have a tax bill” depending on the insolvency exception or deductions for losses available to the seller. At Short Sale Breakthrough 09 we go through these issues so the investor or real estate agent is prepared to engage in this discussion when the seller raises the question.
However the most important point here, which I would suggest you take note of Ms. Attorney, is that neither you (I presume you are not a tax attorney), nor the real estate investor or agent is the appropriate person to be giving a seller tax advice. While it is true that there are tax consequences, the seller’s tax adviser or CPA is the person to analyze the entire situation and determine whether or not the tax consequences outweigh the advantages to the seller of pursuing a Short Sale and avoiding a foreclosure.
P.S. Investors who are SERIOUS about making big bucks on Short Sales need to know how to answer skeptical questions like these. That’s why the face-to-face training you get at Breakthrough 09 in Orlando is unlike anything else out there.
