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Q: I short-sold a house that was my primary residence and received a 1099 for the balance of my debt that was forgiven. Altogether, I lost $100,000 of my cash payments on the house. Can I show a capital loss on the sale on my income tax?
The short answer is no. You cannot declare a deductible capital loss on the sale of your principal residence, whether or not it was a short sale.
If you profit by a sale of an asset (either personal, investment or business), you must report the gain on your income tax return.
If you sell a business or investment asset at a loss, you can report that loss on your tax return (either an ordinary loss or capital loss, depending on the facts and circumstances).
On the other hand, a loss from a sale of a personal-use asset does not qualify as an ordinary loss or capital loss. The loss is non-deductible for federal income tax purposes.
Though this was not part of your question, the IRS Form 1099 (probably a Form 1099-C) issued to you on debt forgiveness can trigger something called "cancellation of debt income" or "CODI.” CODI is generally ordinary taxable income. You may exclude CODI from taxable income under federal tax code section 108 that provides five different types of exclusions:
(1) debt cancelled in bankruptcy,
(2) debt cancelled at the date when the taxpayer is insolvent ("insolvent" means that the taxpayer has debts in excess of assets, see IRS publication 4681 for a discussion and a worksheet),
(3) cancelled debt that is considered "qualified farm debt,"
(4) cancelled debt that is considered "qualified business real property debt," and
(5) cancelled debt that is considered "qualified principal residence debt" is excluded.
Be careful about "qualified principal residence debt." It includes only debt that was used to buy or improve a principal residence. It is NOT necessarily all debt secured by a principal residence at the time of the short sale. Example: Bob bought a principal residence in 2000 for $100,000 with an $80,000 loan and a $20,000 down payment. Bob refinanced in 2005, obtaining a new loan for $380,000. He used none of the proceeds to improve the principal residence. Assuming the original $80,000 loan and the $380,000 loan were interest only loans, only $80,000 of the $380,000 loan is considered "qualified principal residence debt.”
Also, there is a distinction about "recourse" debt and "nonrecourse" debt. Purchase money debt on principal residences that has never been refinanced is generally not subject to the CODI rules. Other rules apply for that. A taxpayer must determine whether the debt is recourse or nonrecourse before worrying about the Form 1099C CODI or the exclusion rules shown above. If in doubt, consult a CPA or attorney who can determine whether the debt is recourse or nonrecourse.
G. Scott Haislet, CPA, Esq. is a tax adviser, estate planner and real estate attorney. You can reach him at (925) 283-1031(925) 283-1031.
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