Our bank has decided to accept a short sale on our home curing our 1st mortgage, paying off part of our 2nd, $93,000 aprox, and forgiving the approx. $135,000 remaining on our 2nd; a home equity line.
The home was our qualified principal residence and we utilized all of the money from the home equity line to make substantial home improvements:
A Complete remodel
A New guest house
A New swimming pool
The mortgage forgiveness exclusion under IRS Sec 108(A)(1)(E) states:
"It does not apply to discharges of second mortgages or home equity loans "unless " the loan proceeds were used to acquire, construct or SUBSTANTIALLY IMPROVE THE TAXPAYERS PRINCIPAL RESIDENCE.
We have all receipts. Should we still be concerned about having to write a very large check to the IRS for the forgiven amount?
1 Answer from Attorneys
You seem to have the requirements down, but you are asking lawyers to provide an answer based on factual matters. While we can advise you on the rules, you will have to determine what expenses are properly characterized in such a manner to add to your basisi and/or avoid income taxation. You will also need to obtain and retain the receipts and proof of payment and purpose of payment to justify your tax position. Discharge of indebtedness iis treated like a cash payment to you. If you can show enough basis, you have no gain anyway. If you do have gain, and it fits factually in the exception, you win. Attorneys can't help beyond confirming the rules.