Here is a great article in regards to real estate and tax consequences..check it out!
NEW YORK (CNNMoney.com) — Did you lose your house to foreclosure this year? Did your lender forgive some of your mortgage debt because you sold it for less than it was worth? If so, you could be facing a big tax hit.
It is IRS policy to tax forgiven debt you are personally responsible for as if it is income. Say, for example, your credit card company settled a $10,000 debt for 50 cents on the dollar. You’d have a debt forgiveness of $5,000, which the IRS would count as income, just like your wages.
The same policy held true for most mortgage debt until 2007, when Congress passed the Mortgage Forgiveness Debt Act. That ended the liability for many homeowners — but not all.
In general, if you lose your home to foreclosure or short sale, where you sell your home for less than you owe, the IRS won’t add insult to injury by counting the difference as income. At least until 2012.
There are four major exceptions to the rule:
1. You did a cash-out refinance and splurged.
Many homeowners took cash out when they refinanced their homes and used the extra dough to pay for new cars, boats or vacations. Say you did that and then got into trouble, losing the house through a foreclosure or short sale. Even if your lender waived the remaining debt, the IRS will treat as income the portion of the forgiven debt that you took out as cash and spent. Only the funds used to actually improve your home won’t be taxed. Yes, even if you spent the money on paying off your student loans or credit cards.
The IRS’ reasoning is that only the money spent on home improvement actually added to your home’s value. And that, presumably, diminished the difference between what you owed on your mortgage and the value of your home when it was foreclosed.
Beware: Some lenders made refinancing offers contingent on homeowners paying off credit card debt, according to Kent Anderson, a Eugene, Ore.-based attorney and tax expert. If you took one of those deals, the refinance money will be reported to the IRS and you will owe taxes on it.
2. You have a home-equity line of credit.
During the boom years, many homeowners tapped soaring home equity to make all sorts of consumer purchases. But the same rules that apply to refinancings also apply to home-equity loans: The IRS will only forgive the tax liability if the loan money was spent improving your home. And, tax experts advise, you’ll need to show receipts to prove you did.
3. You lost your vacation home or investment property.
So the market tanked and you lost your vacation home. Unfortunately, if you didn’t use it as your primary residence for at least two of the previous five years, you’re going to pay the tax man.
More common, however, may be the case of investment properties gone sour. During the housing boom, buying homes for investment purposes soared, accounting for 28% of all sales during 2005, according to the National Association of Realtors. (Vacation homes made up 12%.) And many of these purchases were made with little down payment.