Ask IRS to Forgive Taxes on Forgiven Debt

Dear Tax Talk,

I short sold my house in 2006. I got hit with big tax bill, which I find outrageous because if I could not afford the house, why does the government think I can afford the tax? My question is: How can I get out of the forgiven debt tax? Can I claim insolvency this late after the fact? -- Robert

Dear Robert,

Of course, it would have been better if you had claimed the insolvency exception when this first came up. If you short sold in 2006, you were at the forefront of short sales since it is a rather new concept. In any event, if your debt was forgiven, the IRS is charging that as income to you. Normally, the statute of limitations on assessment of IRS taxes is three years from the date you filed. This would mean 2006 is closed by statute for amending or adjusting your tax.

However, tax mistakes are not set in stone even though closed by statute. The best way to get your case back in front of an IRS agent is to file an Offer in Compromise, stating that you have doubt as to liability for the tax. The IRS agent may consider removing a tax assessment if you can show you were able to avoid the assessment by establishing insolvency. Use IRS Form 656 to apply for an Offer in Compromise.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

Bankrate's content, including the guidance of its advice-and-expert columns and this website, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this website is governed by Bankrate's Terms of Use.