Short Sale Tax Implications

Find out if you'll have tax liability for mortgage debt that your lender forgives after a short sale.

If you are a homeowner facing foreclosure, a short sale might sound like the perfect solution to avoid foreclosure. However, if you complete a short sale, you could be subject to an income tax hit. Read on to learn more about when short sales result in tax liability and when you are exempt from paying such taxes.

What Is a Short Sale?

A short sale is when a homeowner sells his or her home for less than the total debt balance remaining on the mortgage and the lender agrees to accept the proceeds from the sale in exchange for releasing the lien on the property. Short sales are one way for borrowers to avoid foreclosure. (You can learn how short sales work in Nolo's Short Sales & Deeds in Lieu of Foreclosure section.)

After a short sale, the lender may decide to come after you for a deficiency judgment. Or it might forgive the deficiencyin which case you might owe taxes.

When the Lender Pursues a Deficiency

In a short sale, the sale price is “short” of the amount you owe to the mortgage lender. The difference between the total debt owed and the sale price is the “deficiency”.

Example. Say you are approved by your lender to sell your property for $200,000, but you owe them $250,000. The deficiency is $50,000.

In many cases, the lender can seek a personal judgment against you after the short sale to recover the deficiency amount. Generally, once a deficiency judgment has been obtained, the lender may collect this amount (in our example, $50,000) from the borrower by doing such things as garnishing the borrower’s wages or levying the borrower’s bank account. (To learn more about techniques the lender can use to collect a deficiency judgment, see our topic on Ways Creditors Can Collect Judgments.)

If the Lender "Forgives" the Deficiency: Tax Implications

On the other hand, the lender may choose to forego pursuing a deficiency judgment, forgive the deficiency amount, and issue you a 1099-C (“Cancellation of Debt”) form instead.

“Cancellation of Debt” as Taxable Income

If a short sale results in a deficiency, but the lender decides not to come after you for payment and forgives the debt, this means you are no longer under an obligation to repay the lender. The lender is then usually required to report the amount of the cancelled debt to you and the IRS on a Form 1099-C. If this occurs, you may have to include the forgiven amount as income for tax purposes.

Example. As in the example above, let’s say you complete a short sale by selling your property for $200,000, but you owe the lender $250,000. The deficiency is $50,000. If the lender decides not to try to obtain a deficiency judgment and issues a 1099-C instead, then you have received a cancellation of debt in the amount of $50,000. This is generally considered taxable income to you.

Mortgage Forgiveness Debt Relief Act of 2007

You might be able to escape tax liabilty for a short sale deficiency if you can meet the requirements under the Mortgage Forgiveness Debt Relief Act of 2007. This Act allows taxpayers to exclude certain types of forgiven debt from their taxable income, as long as the forgiven debt was used to:

  • buy, build, or substantially improve a principal residence, or
  • to refinance debt incurred for those purposes.

This exclusion only applies to debt that was forgiven in 2007 through 2016, though it’s possible that Congress will extend it. They have done so four times now.

You can only exclude $1 million of forgiven debt, or $2 million if you are married and filing a joint tax return.

Other Ways to Excape Tax Liability for a Deficiency

There are some other situations when cancelled debt is not taxable, including:

  • Debt discharged in bankrptcy. Debts discharged through bankruptcy are not considered taxable income.
  • Insolvency. If you are “insolvent” (meaning your total debts are more than the fair market value of your total assets) at the time that the debt is cancelled, the forgiven debt may not be taxable.

Additional Tax Assistance

If you have tax questions, the IRS Taxpayer Advocate Service may be able to help. For more information, you can call 1-877-777-4778, TTY/TDD 1-800-829-4059, or go to!

You might also qualify for free or low-cost assistance from a Low Income Taxpayer Clinic. To find information on Low Income Taxpayer Clinics in your area, go to

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