Everyone hopes to make a profit when selling a home. Unfortunately, that is not always the case. Sometimes you may sell your home for less than you paid for it because at time you need to sell, the market is down. Money.com reports that nearly 25 per cent of all homes sold in the U.S. sold at a loss in 2008, and that trend was expected to continue. Selling at a loss is bad enough, but it can also cause problems for you with the IRS.
Most likely, if you sell your home for less than you paid for it, you are going to need to bring a check to the settlement table rather than walking away with one. You will need to pay the lender the difference between the home sale price and the amount still owed on the mortgage. You may be able to convince your lender to forgive some or all of the difference. This is called a short sale.
Tax Reporting of Loss
The difference between your sale and what you owe represents a capital loss. However, it is not a loss that you can claim on your taxes. According to Smart Money, the IRS only allows you to write off capital losses on investment properties. If you lose money on your home, it is considered a nondeductible expense.
Owing More Than the Sale
There is a scenario where you can technically sell your home for more than you paid for it, but you still owe more than you make in the sale because of the mortgages. For instance, you paid £188,500 for a home that you sell for £211,250, but you owe £227,500 in first and second mortgages. The IRS views this as a £22,750 gain rather and a £16,250 loss. This means you may owe tax on the gain unless you are able to exclude it from your taxes under the home sale gain exclusion break, according to Smart Money.
Debt Discharge Income
If you are able to convince your mortgage lender to forgive some of your shortfall, the IRS considers that amount income that you need to report on your taxes. The Mortgage Forgiveness Debt Relief Act of 2007 provides some relief on principal residence debt through 2012. The debt must have been accumulated to acquire, build or improve your principal residence.
If your lender agrees to a short sale of your home, you can expect it to negatively affect your credit. In the short run, having a strong credit rating may not be as important to you as getting out from under the debt. In the long run, you will find that you will be paying higher interest rates on your next home, or a potential landlord may have some scepticism about your ability to pay rent. You can rebuilt your credit, but it will take time.