Federal & State Income Tax Consequences of Short Sales of Principal Residence

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This Memorandum describes the federal and state income tax consequences when a homeowner decides to do a short sale with his or her primary residence. There are two possible "income tax results," a traditional income result, i.e. was there a gain or loss on the sale, and "income from the cancellation of debt," i.e. the lender agrees to forgive the unpaid balance of the loan as part of the short sale. It is noted that whether the loan was nonrecourse or recourse can have significantly different consequences. The Memo then describes the possible "exclusion" of the COD income provided by IRC sec. 108. Finally, the Memo describes the "ordering rule" in Section 108 that might not allow all of the forgiven debt to be excluded from income.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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