Originally published on Passive Activities and Other Oxymorons on February 20th, 2011.
I received a very gratifying email yesterday :
We are happily settled in our new home. Thank you for all your help.
The lady who sent it had been trying to purchase a home on a short sale where the seller was receiving a relocation grant. The seller had an outstanding IRS lien. The collection agent responsible for releasing the lien finally gave in after she sent him a copy of CCA 201102058 which she had learned about from my blog post. What is really intriguing is this particular development seems not to have attracted any notice to speak of. Check out this search. It seems like, except for one broken link, I'm the only one who has written on this.
My friend, Stephen McWilliam, a Florida realtor has suggested to me that this may be because the HAFA relocation money is not really flowing yet, making the problem more of a theoretical one. Stephen is a really smart guy. I have a pretty good aptitude for what I do and I have experience and focus. It's always a little humbling to realize that other people I meet in business and am able to help would probably be better at what I do than I am. Fortunately they chose other fields. I think in economics this is referred to as "comparative advantage". At any rate, Stephen mentioned something about the tax aspects of short sales that had never occurred to me. Presumably when you are behind on your mortgage you owe both interest and principal. When the short sale goes through for some transitory moment the money is yours even though your don't get to touch it. If the bank applies the proceeds to interest, you should potentially be able to deduct that interest and should be looking for a Form 1098. I usually try to tie my posts to specific pronouncements, but I haven't been able to find anything that addresses this head on.
This is separate from the issue of getting a Form 1099-C which may require you to recognize income on a short sale.