Today TaxMama® hears from YbSick in the TaxQuips Forum, with a common question.  “In a short sale where they abandoned the property and they receive a cancellation of debt, is it non-taxable since it was on their personal residence? Is there a time limit on how long after they move out of the property it can still be excluded? Assume for the time being that they did not borrow more money above the original mortgage.”

Dear YbSick,

Mike Reed, our EA in California has good news.

The Mortgage Debt Relief Act of 2007 was extended through Dec 31, 2013.

The provision allows exclusion of acquisition (or improvement) debt from income. There is no set time limit between the date the T/P leaves or abandons the property and when the 1099-C is issued. Use Form 982 to avoid taxation on the cancelled debt.

Remember that even though the cancellation of debt income may be excluded, there could be a gain on the sale – which is usually excluded by §121, as sale of a personal residence. But be sure to report the transaction on the new Form 8949, so that IRS has a record of this.

And remember, you can find answers to all kinds of questions about short sales and other tax and business issues, free. Where? Where else? At www.TaxMama.com.

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