At a recent luncheon for Las Vegas Bankruptcy Attorneys, a representative from the IRS gave a presentation on "up and coming" issues in bankruptcy with regard to the IRS. Most of the presentation was not too "newsworthy" but the final topic literally had an entire room of bankruptcy attorneys and Chapter 7 Trustee's gasping. The IRS informed that when a lender does not foreclose on a property or if a short sale of a property that is surrendered in a bankruptcy does not occur while the Chapter 7 bankruptcy estate is still open, there may be tax consequences for the debtors. While the cancellation of debt does not create a tax issue as the IRS does not impose tax liability for discharged debt, the disposition of property post-petition could create a "gain" for tax purposes depending on when the disposition occurs. (If it is your primary principal residence, then the exclusion of $250,000 single, $500,000 married would still apply for any perceived "gain" BUT, for investment property, there could be a tax issue.)
What does this mean for Chapter 7 debtors? To ensure that you avoid any post-petition disposition of real estate tax consequences, you should consider listing your property for sale and try to coordinate selling the home while the bankruptcy is still open. This will require the cooperation of the bankruptcy trustee as well as the loan servicer, as an approval of the short sale by the court or an abandonment by the trustee will be necessary in order for the sale to go forward while the bankruptcy case is still open.
Having called a trusted CPA immediately after the luncheon to discuss this issue, she advised that even if the disposition couldn't be completed while the bankruptcy case was still open, debtors should still try to complete disposition (short sale or foreclosure) during the same year that the bankruptcy is filed to minimize exposure. She said in most cases, tax liability will not occur, but it is still something to be concerned with. SO, for those debtors that are waiting for the bank to foreclose, it may be worth a call or appointment with your tax professional to see where you stand, and to see if you should try to short sell the house before the end of the year. For those in contemplation of bankruptcy, make sure your bankruptcy attorney is aware of this issue and that you consult with a tax professional as well as an attorney with regard to the disposition of your property. Like so many things in life, timing is everything, and it now seems that leaving it up to the bank to foreclose "whenever" could be a dangerous course to take.