Coalition Corner:
Business training tools for HR staff, real estate licensees and other
service professionals in the relocation and real estate industries
Short Sales:
Some Taxing Issues Can Arise
by Peter K. Scott, Worldwide ERC®/Coalition Tax Counsel
Washington, DC
© 2008, Worldwide ERC® Coalition
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Program objectives
• This program supplements an editorial feature
in Worldwide ERC®’s Mobility magazine
• This segment will:
– Examine some of the basic tax implications
of selling a home subject to a short sale.
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Definition of Short Sale
A “short sale” occurs when a seller is unable
to realize enough on the sale of a home to
cover outstanding mortgage debt.
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Example of a Short Sale
• A transferee owes $300,000 on a mortgage (or on
the mortgage plus an associated home equity loan
or second mortgage)
• The home can only sell for $250,000
• The transferee is “short” by $50,000, and is in a
situation known as “negative equity”
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Circumstances Can Vary
Scenario A
• Employee A bought a house for $750,000 two years ago, at the
peak of the market, after a transfer from Kansas City to Miami.
• The employee obtained a 100%, interest-only adjustable rate
mortgage for the purchase, because it was the only way the
employee could afford a comparable home in Miami.
• The value of the home is now $650,000, and the mortgage is still
$750,000.
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Circumstances Can Vary
Scenario B
•
Employee B purchased a home in Miami five years ago for
$450,000 with a $400,000 mortgage.
•
As home prices escalated, Employee B engaged in two rounds of
refinancing in which the employee took out equity of $200,000 to
buy other assets, and also obtained a home equity line of
$100,000, which is currently maxed out.
•
Total debt is $690,000. The house is now worth $650,000.
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Approaches to Negative Equity…
• If the employer simply gives an employee money to pay
negative equity, the payment is taxable as wages, and
withholding and payroll taxes are required.
• The same result would follow if the employer purchased
Employee A’s home at the $650,000 market price and
paid off the $750,000 mortgage. The excess is
considered compensation and subject to taxes.
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Approaches to Negative Equity…
• If the lender agreed to reduce the amount owed, any
amount of debt reduction would generally be taxable to
the employee as “cancellation of indebtedness” income.
• However, in late 2007 Congress passed legislation that
foregiveness of an acquisition mortgage up to $2 million
on a principal residence during 2007-2009 is not taxable.
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Approaches to Negative Equity…
• The employer could loan the employee money to pay the
negative equity, with no tax consequences, so long as
the loan is properly structured as a real debt, with a
repayment schedule, a market rate of interest, and the
usual security and enforcement provisions.*
*Note that section 402 of the Sarbanes/Oxley Act would prohibit
such loans to covered executives of publicly traded companies.
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Approaches to Negative Equity…
• If the company wants to loan the employee money
interest-free, the issue becomes more complicated.
– Section 7872 of the Code imputes a market rate of interest to
interest free loans exceeding $10,000 between employer and
employee. Imputed interest has a number of undesirable results.
– Although there are special rules that allow certain interest-free
employee relocation mortgage and bridge loans, a loan to cover
negative equity generally would not meet the requirements.
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Conclusions
• Short sales are becoming more prevalent, especially in
certain declining regional markets.
• Companies need to familiarize themselves with the tax
issues that can arise, to help make sound decisions in
developing and implementing home purchase program
policies.
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More Information Available…
This presentation only summarizes some tax issues that can arise in
short sales, and there are a number of legal issues to consider as well.
A full, detailed discussion of tax issues can be found in the Worldwide
ERC® Coalition’s Tax & Legal MasterSource
(http://www.erc.org/coalition/tax_legal/index.shtml) article “Short Sales,
Foreclosures, Negative Equity and Loss on Sale.”
See also www.irs.gov for additional information on this and other
foreclosure and debt cancellation issues.
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