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I want to share with you some information that came to me from Chris Sorensen and the HELP project.
If you are in a situation where you are considering; A Short Sale, Loan Modification, Letting your property go to Foreclosure or even Bankruptcy, there are Several Tax implications to consider before taking any of the before mentioned routes. I would really hate for you to be in a position where after the fact you learn that you not only lost your home, but now owe money to the IRS.
Here is the information that Chris suggest you take to your CPA so he can help you understand where you and your particular situation would stand.
DEBT CANCELLATION OVERVIEW
Prepared by Jerrie Muir, IRS Tax Consultant
March 5, 2010I. General Rule. When a taxpayer borrows money from a commercial lender and lender later cancels or forgives the debt, the cancelled amount may have to be included in income.
II. Common Exceptions:
Qualified Principal Residence Indebtedness- IRC Section 108(a)(1)(E)
Bankruptcy- IRC Section 108(a)(2)(A)
Insolvency- IRC Section 108(a)(1)(B)
Certain Farm Debts
Non-Recourse LoansIII. Mortgage Forgiveness Debt Relief Act of 2007 (Public Law 110-142)
a. Generally allows taxpayers to EXCLUDE from income debts forgiven or cancelled which were used to buy, built, or substantially improve a home OR refinance debt used for one of those purposes
• Debt must be secured by a home
o Principal residence defined under Treas. Reg 1.121-1(b)(1)
• Maximum amount treated as Qualified Principal Residence Indebtedness is $2 Million ($ 1 Million for taxpayers who file a Married Filing Separate Tax Return
• Applies to 2007, 2008, and 2009 Tax Returns
• Forgiven debt excluded from income is reported by taxpayer on IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Adjustment), which is attached to the filed tax return
• Forgiven debt of a taxpayer is reported by the lender on Form 1099-C, Cancellation of Debt
• Taxpayer can also exclude debt if they are insolvent or debts are discharged through Title 11 Bankruptcy
o Taxpayer may make an election to reduce the basis of depreciable property by the excluded income rather than the other tax attributes- IRC Section 1082
• Forgiveness of a Non-Recourse Loan, which is a loan where the lender can ONLY repossess the property and not pursue you personally- Cancellation of this type of debt is NOT TAXABLE
• Mortgage Forgiveness Debt Relief Act does NOT apply to debt forgiven on second homes, rental property, business property, credit cards, or car loan
• Capital Loss on the sale of a primary residence is NOT deductible on a tax return• EXAMPLE:
2002
Home Purchase $435K
1st Mortgage $420K
Down payment $ 15K2003
2nd Mortgage obtained to build $ 30K
to build additional room2006
1st and 2nd Mortgages $440K (Loan Balances)
(Before Refinance)
Fair Market Value of Home $500K
Refinance Amount $475K (Cash out of 35K)2008
1st Mortgage $475K (Loan Balance)
Fair Market Value of Home $425K
Loan Modification Amount $ 40K• Taxpayer has 40K in cancelled debt
• 35K Non-Qualified Principal Residence Indebtedness is reported on Form 1040, Line 21, as Other Income
• 5K Qualified Principal Residence Indebtedness is reported on Form 982IV. The Emergency Economic Stabilization Act of 2008 (Public Law 110-343)
• Extends the mortgage debt relief on Qualified Principal Residence Indebtedness for tax years 2010, 2011, and 2012V. Recourse Debt- When the amount of debt discharged exceeds
Fair Market Value of property
a. Difference is cancellation of debt and considered income
i. Treas. Reg. 1.1001-2(c), Ex. 8; IRS Revenue Ruling 90-16VI. Non-Recourse Debt-
b. Foreclosure/Deed of In Lieu of Foreclosure treated as deemed sale with proceeds equal to the amount of nonrecourse debt
c. Abandonment of real property that has nonrecourse financing treated as deemed sale
d. NO cancellation of debt when treating the nonrecourse debt principal as the amount realized from a deemed salePlease seek good counsel with an acredited CPA and depending on the case perhaps you will need a lawyers advice as well.
Please be wary of companies charging up front fees for any help with one of the situations mentioned before, it is many times not legal and in most cases a bad idea.
I have just added a new post to my blog. If you are considering a Short Sale, Foreclosure, Bankruptcy or Loan Modification...here is a quick thought before you make a decision.
