Sales of Residence-Foreclosure-Shortsales

Sales of a Principle Residence:

American 2012 Taxpayer Relief Act: Mortgage Debt Forgiveness

The American Taxpayer Relief Act of 2012 (2012 Taxpayer Relief Act) provides a one-year extension of the exclusion from income for the forgiveness of debt on a principal residence. The exclusion now applies to discharges of qualified principal residence indebtedness occurring on or after January 1, 2007, and before January 1, 2014. During the exclusion period, taxpayers who are caught in the current subprime mortgage crisis do not have to pay taxes for debt forgiveness on their troubled home loans.

Debt forgiveness relief was originally granted to taxpayers through the Mortgage Forgiveness Debt Relief Act of 2007, effective for debts discharged after January 1, 2007 and before January 1, 2010. The 2008 Stabilization Act extended this relief to debts discharged before January 1, 2013.

In general, the amount of the forgiveness of debt on a principal residence that is included in income is equal to the difference between the amount of the debt being cancelled and the amount used to satisfy the debt. The tax on this income creates an additional burden to taxpayers already struggling financially. The 2012 Taxpayer Relief Act provides relief from this burden so that taxpayers can recover faster. These rules generally apply to foreclosure or the exchange of an old obligation for a new obligation.

If you have any questions regarding this provision or if you have concerns regarding a home foreclosure, we can answer any questions and discuss your options in greater detail. Please call our office at your earliest convenience to arrange an appointment.

Tax Consequences of Home Mortgage Foreclosure

Many Americans are falling behind in their mortgage payments, in large part due to adjustable rate mortgages (ARMs) that have reset to higher rates. The delinquency rate for mortgage borrowers continues to increase, and a record number of homes are entering the foreclosure process.

The tax consequences that accompany a home mortgage foreclosure can further weaken an already tenuous financial condition. When a lender forgives any portion of a mortgage loan, taxable “cancellation of debt” income generally results. However, there are several instances where cancellation of debt income is not taxable, the most common involving bankruptcy, insolvency, qualifying farm debts, and non-recourse loans.

Another component of the home foreclosure scenario is capital gain income. Because a home foreclosure is treated like a sale, capital gain is recognized if the property’s fair market value exceeds its basis. However, a taxpayer may exclude up to $250,000 ($500,000 for joint filers) of this gain if the property was owned and used as a principal residence for two of the previous five years.

A taxpayer that owes additional tax due to a home mortgage foreclosure can request a payment agreement with the IRS, or may qualify to enter into an offer-in-compromise that will provide a partial abatement of the tax.

If you have concerns regarding a home foreclosure, we can answer any questions and discuss your options in greater detail. Please call our office at your earliest convenience to arrange an appointment.

Tax Implications of a Short Sale

When considering a Short Sale, it is important to understand possible tax implications. When completing a Short Sale on your property, you may receive a form 1099-C for the amount of the lender’s losses. This is considered a loan forgiveness in the eyes of the IRS. There have been some recent changes which offer some relief so it is important to understand the implications.

It’s not so unusual these days to have mortgage debt that exceeds the current value of your principal residence. If you hang on to the property long enough, you have a reasonably good chance of riding out the storm with little or no harm done. On the other hand, if you have to sell now, you face what’s called a “short sale” — which means selling for a net sales price (after subtracting commissions and other closing costs) that’s less than the outstanding mortgage debt.

To the extent debt is forgiven, you have so-called debt-discharge income, or DDI. The general rule is that DDI is taxable income. For the year that DDI occurs, the lender should report the amount to you (and to the IRS) on Form 1099-C. Happily enough, there are some taxpayer-friendly exceptions to the general rule that DDI is taxable.

Please consult with your CPA to learn more.

Short Sales on Investment Properties

Even though this Act protects only primary residence homes, rest assured we have performed countless short sales on investment properties, too. Do not be misled into thinking that if you are not covered by the Mortgage Relief Act that you will absolutely have to pay taxes. Many of our investor clients have paid nothing, some have had to pay thousands of dollars, and some have received a rebate. Because tax laws are interpreted so differently due to an individual’s income, assets, deductions, and losses on the home, it is impossible to know exactly what the tax impact is on an investment property. Always consult with a very knowledgeable accountant who specializes in real estate to help provide clarification.

Sale of a Residence with a Home Office

As someone who sees clients in an office located in your home, you’re certainly aware of the tax breaks available for such usage. Although you have been claiming home office deductions for a number of years, you may not know about a potentially expensive tax trap that can hit you when the time comes to sell your home.

If you’re planning to sell your home at a profit and “move up” to another one, you may be assuming that there won’t be a tax to pay on the sale. Usually, that is a pretty good assumption because of the $250,000 exclusion of gain tax break on the sale of a principal residence (joint filers get a $500,000 exclusion). However, when you have a home office, or have taken the home office deduction in the past, you may have an extra bit of planning to do in order to secure the full benefit of the exclusion.

Fortunately, the IRS eventually fixed a problem with the home sale exclusion that threatened to wreak havoc on those taxpayers who have a home office and take depreciation deductions for it. Prior to issuing corrective regulations, the IRS operated under the rule that, if you used your residence for both personal and business purposes, you would be treated as having sold two separate properties for purposes of using the home sale gain exclusion: a personal residence and a business building. The profit you realize on the sale of your home would be entitled to the $250,000/$500,000 exclusion, but any profit you realize on the sale of the business part of your property would be taxed.

Final IRS rules no longer require most taxpayers who claim the home office deduction to allocate gain between business and residential portions of their home if the business use occurred within the same dwelling unit as the residential use. Instead, a portion of your gain subject to recapture tax is the amount of depreciation you deducted in the past as a home office expense.

If you have plans to move or set up your home office to a free-standing garage, guest house or backyard bungalow, however, you need to think carefully about the tax implications. In cases in which your home office is not in the same building in which you reside, the old rules continue to apply and you may find you will lose out on a significant portion of your home sale exclusion.

If you currently have an office at office or you have plans to set one up, you should also consider a”simplified” option that the IRS is making available for the first time starting in 2013. This simplified option allows a deduction of $5 per square foot for home office space, up to a maximum deduction of $1,500 for the year. If this option is used, there is no depreciation that needs to be factored in when you later sell your residence.

If you need any help in arranging things to save as much tax as possible on the sale of your home and office, we will be happy to assist you. Please do not hesitate to call any time for a confidential discussion.

We offer a free initial consultation for real estate businesses. Call us today at 714-533-2600 and to schedule a mutually convenient time to meet.


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