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Question for the Money Doctors

Question submitted on Jul 22, 2013.

Question

My husband had a house before we got married. We have since bought our own house. We have a tenant in the old house, but having trouble making payment. We have contacted the mortgage company, and they have given us our options. We can do a short sale, but wondering how bad will it hurt our taxes this year. They say we have to claim the remainder as income which will be about 75,000.00 and we make 72000.00 a year. Can you help us understand how bad it will hurt us?

Answer

A short sale can bring immediate financial relief, but may have negative consequences.

First, the debt canceled as a result of the short sale will be treated as income. The estimated $75,000 will not only be taxable, but could push you into a higher tax bracket with an increased percentage of tax liability. If you were at all insolvent at the time of the canceled debt, where your total liabilities were greater than your assets, it may be possible to have some or all of the $75,000 excluded from your income. See IRS Publication 4681 for the exact criteria.

Second, the short sale will be reported to credit bureaus, potentially dropping your credit score 100 points or more, and remaining in your credit history for up to 7 years. The impact on your rating is no less detrimental than foreclosure. Try negotiating with your lender to have them report the short sale as “paid” rather than “settled” to avoid the damage to your scores.


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