Avoiding Tax Liability From Deed In Lieu Or Short Sale

Here’s another idea about dealing with the threat of deficiency judgments and the income tax consequences of a deed in lieu or short sale. At a social gathering over the weekend I had a conversation with Larry Kosto, a well-known creditor collection attorney, about how debtors can avoid income tax liability when a bank forgives debt underlying a mortgage. Larry said some of his creditor clients who are amenable to taking a deed in lieu or a short sale have entered into a written stipulation with the borrower that the value of the property surrendered is equal to the amount of the underlying debt. In such event, the lender is agreeing that it is fully satisfied by taking back the property. There is no deficiency liability. If the lender does not pursue a personal judgment against the borrower the borrower has not benefitted from taxable forgiveness of debt.

If you negotiate with your mortgage lender about voluntary surrender of the property see if they will stipulate that there is no difference in the amount of debt and property value to avoid potential income tax liability from debt forgiveness.