In terms of the back property taxes owed on a home that is sold through a short sale, the bank will typically cover this expense and seller’s should be free and clear of this liability going forward. In most states governmental property taxes convert into a lien on a property as soon as they are due — even before they fall behind, in most areas. That just means that your escrow provider and/or title insurer have to clear those tax liens, making sure they are paid up to the date of closing, before they are able to transfer clear title to the buyer.
In the average short sale situation, what happens is that the seller’s bank(s) has to direct some of the proceeds from the sale of the home to cover; any back taxes on the property, agent commissions, transfer taxes and such before they can apply the rest of the sale price to cover the outstanding mortgage balance(s). When escrow closes, and I mean starting the day of or the day after, the buyer is responsible for property taxes incurred from that day forward.
In some transactions, though, there are back expenses that are not extinguished by a short sale.
The most common are homeowners association dues that are not paid off or waived in the short sale. Some HOAs will continue collection efforts on back dues — not as a lien against the property under its new ownership, but as a personal debt of the former homeowner.
The other are second or even third mortgages in which the lender expressly agreed to let the short sale go forward on the condition that the seller or former homeowner pay some or all of the outstanding balance over time and did not agree to a full release.
Such terms would be expressed and would be pursuant to the short sale approval agreement, so you would be made aware of such obligation if the lender does not agree to a full release.
Now to the question of paperwork. At or just after closing, depending on where you live, you should receive a document on legal-sized paper called a HUD-1 closing statement. As with any real estate transaction, hang on to that just in case you don’t get any additional paperwork from your lenders.
To the extent that some portion of your mortgage balances were forgiven by the banks, that gap — that deficiency — is normally subject to income taxes. It’s called cancellation of debt income, or CODI.
This sort of “income” (essentially a loan that was forgiven) is usually documented by the bank sending you a Form 1099-C, in January — just as if you’d earned that income. So, you might see two of these statements in the mail early next year.
I say “might” only because some of the mortgage lenders that are no longer operating as banks or lenders aren’t sending these statements out anymore. In that event, your HUD-1 might end up being the only documentation you receive.
That said, if you close your short sale before January 1st, 2012 chances are you’ll be exempt from income taxes on your CODI “income” under the Mortgage Forgiveness Debt Relief Act of 2007. The act applies to qualified principal residence indebtedness forgiven in calendar years 2007 through 2012 (it is believed that this relief will be extended however, at the time this blog posted was written an extension has not yet been signed into law).
You’ll still need to let the IRS and your state tax agency know of your short-sale specifics, but you’ll be able to invoke the terms of the act (most states now have parallel provisions) to avoid being charged with income taxes on the forgiven debt, assuming the home was actually your primary residence, your mortgage debt was $2 million or less, and certain other guidelines are met.
Visit this dedicated page on the IRS website for more details, and best of luck on your personal financial recovery endeavors.
