Prior to the adoption of President George W. Bush’s “Mortgage Forgiveness Debt Reduction Act and Debt Cancellation” in 2007, all debt forgiven in a short-sale was taxed as regular income. What this means is the difference between exactly what the home offered for was handled as earnings for the tax year and that which you owe the lender. That changed. It enables citizens to exclude debt forgiven in the sale of a primary home from 2007
Await your lender to send you Form 1099-C, Cancellation of Debt. You need to receive it in the post by Feb. 2 in the year following the short-sale. If the type isn’t received by you, contact the lender and request a duplicate. The level of debt that has been canceled in the short-sale will likely be recorded in Box 2.
Find IRS Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).” This type is contained in several popular tax software applications and you can even download it in the Internal Revenue Service web site.
Put in tax identification number and your name on top of the kind, in the areas supplied.
Check the box to the right of line 1e, “Release of competent principal dwelling indebtedness,” on IRS Form 982.
Fill out line 2, “sum of discharged indebtedness excluded from gross revenue,” on Form 982, utilizing the number from Box 2 on the 1099-C form you obtained from your bank.
Attach 982 for your tax return.