Submitted by Attorney Chris Charles

In typical fashion, the United States Congress waited until the 11th hour to address the looming “fiscal cliff.”  In doing so, Congress extended a number of tax exemptions, including the 2007 Mortgage Debt Relief Act (the “Debt Relief Act”).  The Debt Relief Act was set to sunset on December 31, 2012.  But pursuant to the American Taxpayer Relief Act of 2012, the Debt Relief Act is extended to December 31, 2013.  This is great news for our local real estate economy. 

The general rule is that the forgiveness of debt is a taxable event.  Thus, a property owner generally must pay income tax regarding any debt forgiveness following a short sale, foreclosure, or deed in lieu of foreclosure, unless a tax exemption applies.  This “phantom income” tax burden is particularly onerous for struggling homeowners who can’t afford their mortgage. 

The Debt Relief Act, however, provides an important tax exemption for many of these struggling homeowners.  Pursuant to the Debt Relief Act, the forgiveness of debt used to purchase or improve a principal residence is not a taxable event.  As a result, in many cases property owners can short sale their distressed property with no tax liability.  And if the short sale transaction is negotiated correctly, the property owner will have no personal liability for the mortgage deficiency following the short sale. 

Although the Debt Relief Act only applies to a loan used to purchase or improve a principal residence, other tax exemptions apply to Arizona property owners that minimize or eliminate tax liability following a short sale in most cases. 

Perhaps of greater importance, the $250,000 tax exemption ($500,000 for married couples) regarding income from the sale of a principal residence remains in effect.  26 U.S.C. § 121.  This important exclusion had nearly been forgotten since the Great Recession, but due to Maricopa County’s incredible real estate appreciation in 2012, this exclusion is once again relevant now that many homes have regained their equity.

If you have questions about Real Estate issues and want experienced legal representation, please call 480-733-6800 and ask to speak with Christopher Charles, or visit our website at Davismiles.com