Short-Sale "Catch-22s" For Sellers (and Buyers)

I've recently posted information on short-sales but yet to address possible tax consequences that occur at the local (city/county), state and federal levels.

Here goes!

In Kitsap County the sale of real property "triggers" a real estate tax of 1.78% on the sale price of the property. If the sale price were $100,000.00, the excise tax due the county would be $1,780.00. This tax amount is deducted from the seller's proceeds at closing.

We have no state income tax in Washington State. But if you live in a state that has an income tax, your state may consider the difference between the outstanding mortgage amount and the sale price as income to be taxed at your marginal tax rate. This is one of the "Catch-22s."

At the federal level, the IRS may consider the amount "foregiven" by the mortgage holder as income and thus taxable at the seller's marginal tax rate. This in another "Catch-22."

By the way buyers, just this week the Washington State Department of Revenue issued direction to escrow companies that it considers the foregiven amount of a short-sale to be subject to the 1.78% excise tax. So...who pays this if the seller has no money? This is the third "Catch-22."

If you're selling under short-sale conditions you need to consult with your accountant to determine the tax consequences.