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Get the IRS to Absolve Tax on a Forgiven Debt

September 6th

In this economy many Americans struggling to pay their debts are forced into foreclosure or a short sale on their property. While a short sale entails the forgiveness of debts owed on the home, it can often come with hidden taxes and penalties.

This tax can be a shock to many who, not being able to make the payments on their home, are also unable to pay the tax owed. However, there are ways to convince the IRS to forgive or reduce amount owed on the tax debt.

1. Collect Documentation.

The first and most important step in getting tax forgiven on a debt is to ensure that you have appropriate documentation. Include all documentation from the short sale, as well as anything that might prove you were insolvent prior to the sale. This could include bank statements, tax returns, or official letters from the IRS.

2. File your Request as Early as Possible for Insolvency Exclusions.

Typically, any debt for which you are personally liable, as well as any associated interest, is included as income and is, therefore, taxable. However, in certain cases there are exceptions to this rule. In particular, there is an exclusion for those who were insolvent immediately before the debt cancellation. The statute of limitations for assessment of IRS taxes is three years from the date you filed. Therefore if you wish to make any amendments, it should be done within this period, ideally before you file a return for the year in which the short sale is made. The sooner the request is filed, the more likely it is that you will be able to prove your case and get the exclusion.

3. File an Offer in Compromise.

For those who may have let the statute of limitations expire, it is still possible to have your case reviewed. The best way to get the IRS to reopen your case is to file an Offer in Compromise, stating you have doubts as to your liability for the tax. In these cases, the IRS representative might consider reconsidering a tax assessment if you can prove you were insolvent. To apply for an Offer in Compromise, use an IRS Form 656.


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