Many people don’t realize that if they go through a short sale or foreclosure that the forgiven debt from their mortgage “could” be a taxable event. In the opening salvos of the housing meltdown, I remember hearing OUTRAGE that someone who bought an overpriced home during the “boom” might have to pay taxes to the government if their home was repossessed. On first blush this sounds crazy or unfair.

However, think about it. You owe $225,000 on a home and the market has dropped or you can’t pay the payments anymore and it sells in foreclosure for $175,000. If your lender forgives the difference, $50,000, the government sees that as income. That $50,000 is (or was) taxable.

In response to public outrage the government passed the Mortgage Forgiveness Debt Relief Act. On your personal residence if you have to go through the experience of a short sale or foreclosure–if the debt forgiven is less than $2million for a couple or $1million for a single person, the government forgives you of any tax owed on that gain. However, for people that go through a short sale or foreclosure on investment property–that gain is taxable.

Of course, consult with a CPA for detailed analysis of how a short sale or foreclosure will affect your unique situation or position.

If you want to read more, visit the IRS page regarding this:http://www.irs.gov/individuals/article/0,,id=179414,00.html