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After a bank forgives your mortgage debt in a short sale, your tax problems may not be over.

The Internal Revenue Service (IRS) views reduced or canceled debt as “income” and you may have to pay taxes on the amount forgiven. Since 2007, about 1.8 million U.S. homeowners have sold via pre-foreclosure sale, and most of those are short sales, according to the RealtyTrac U.S. Foreclosure Sales Report. Another 12.5 million borrowers are “underwater” on their mortgages, at higher risk for so-called strategic default.

When lenders cancel a debt of $600 or more, by law it must send you and the IRS a 1099-C tax form, entitled Cancelation of Debt, which contains information regarding the canceled debt. Under the Mortgage Debt Relief Act of 2007, if your mortgage debt on your principal residence was canceled between 2007 and 2012, the forgiven amount would not be taxable. The law only applies to primary residences, not second homes or investment property.

Here’s the key. Regrettably, the Mortgage Debt Relief Act of 2007 is set to expire on Dec, 31, 2012. Rep. Charles Rangel, D-N.Y., has introduced a bill (H.R. 4202) to extend the tax relief act. If the Mortgage Debt Relief Act is not extended, the number of bankruptcies could skyrocket after 2012. Waiting to do a short sale after 2012, a homeowner may incur serious tax penalties that they would avoid by short selling before Dec. 31, 2012.

Taxpayers are required to declare any canceled debt on their tax returns by attaching Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to the tax return. Instructions on how to fill out the form are contained in Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments.

As always, consult with a tax professional about your specific situation. For more details about mortgage forgiveness on first and second mortgages, or a refinanced mortgage call the IRS tax assistance line at 800-829-1040.

IRS Provides Tax Relief to Victims of Hurricane Isaac; Return filing and Tax Payment Deadline Extended to Jan. 11, 2013

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WASHINGTON –– The Internal Revenue Service is providing tax relief to individuals and businesses affected by Hurricane Isaac.
Following recent disaster declarations for individual assistance issued by the Federal Emergency Management Agency, the IRS announced today that affected taxpayers in Louisiana and Mississippi will receive tax relief, and other locations may be added in coming days based on additional damage assessments by FEMA.

The tax relief postpones various tax filing and payment deadlines that occurred on or after Aug. 26. As a result, affected individuals and businesses will have until Jan. 11, 2013 to file these returns and pay any taxes due. This includes corporations and businesses that previously obtained an extension until Sept. 17, 2012, to file their 2011 returns and individuals and businesses that received a similar extension until Oct. 15. It also includes the estimated tax payment for the third quarter of 2012, normally due Sept. 17.

The IRS will abate any interest, late-payment or late-filing penalty that would otherwise apply. In addition, the IRS is waiving failure-to-deposit penalties for federal employment and excise tax deposits normally due on or after Aug. 26 and before Sept. 10, if the deposits are made by Sept. 10, 2012. Details on available relief, including information on how to claim a disaster loss by amending a prior-year tax return, can be found on the disaster relief page on IRS.gov.

The tax relief is part of a coordinated federal response to the damage caused by the hurricane and is based on local damage assessments by FEMA. For information on disaster recovery, individuals should visit disasterassistance.gov.

So far, IRS filing and payment relief applies to the following localities:
• In Louisiana: Ascension, Jefferson, Lafourche, Livingston, Orleans, Plaquemines, St. Bernard, St. Charles, St. John the Baptist and St. Tammany parishes;
• In Mississippi: Hancock, Harrison, Jackson and Pearl counties.