Is it true that the IRS will count this debt relief as income and tax us for it?

Edwards Finance > Debt Consolidate

Q. We recently sold our house in CA through the pre-foreclosure/short-sale program. The final sales price was about $25,000 less than the loan amount. Is it true that the IRS will count this debt relief as income and tax us for it? If so is there a way to avoid this?

A. The rules get a bit involved. If the lender has no recourse against your other assets, generally the outstanding entire balance of the loan is treated as the sales price for purposes of computing a gain or loss on sale. Alternatively, if the lender does have recourse against your other assets, then only the sales price would be used in calculating the gain/loss on sale. However, if the lender decided not to pursue collection of the remaining balance, that would be considered forgiveness of indebtedness income and treated as ordinary income under the Internal Revenue Code. Somewhat offsetting that, though, is the fact that if you can establish you were bankrupt or insolvent at the time the debt was forgiven, the income could be excluded under IRC Section 108. Which treatment is better in your case depends on your overall situation. If you would have a loss on sale even using the whole loan amount as a sales price, the first treatment likely is better. However, if you'd recognize a gain using the loan amount as the sales price *but* you are insolvent, then the second treatment could result in a lower tax. What the above suggests is that you should consult with a local tax professional to decide which treatment is appropriate in your case. Failing to consult with a local professional could result in making an expensive mistake in computing your taxes.

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