The 2007 financial crisis continues to loom over homeowners who own underwater properties. What owning underwater property means for homeowners is that the home’s current market value is less than the mortgage balance, making it impossible to sell or refinance the home without the lender’s approval. The quagmire of financial indebtedness created by current tax laws and policy related to Mortgage Short Sale Transactions, or MSSTs, for homeowners creates an onerous tax liability on taxpayers selling underwater properties. The government and lenders, through various programs implemented to help distressed homeowners with underwater properties, created a belief among homeowners that MSSTs are a positive vehicle for selling their underwater properties. Prior to 2007, MSSTs were virtually non-existent. By forgiving the mortgage loan balance, however, lenders exposed homeowners to two situations. First, homeowners face exposure to possible deficiency judgments for the amounts of the forgiven loan balances, which some state laws addressed. Second, homeowners incur potential unavoidable tax liability created by federal and state tax laws for the forgiven indebtedness, which is considered taxable income. It is the latter of these two situations facing middle-class homeowners with properties underwater that this article addresses.

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