SIMPLIFIED EXPLANATIONS OF SHORT SALES AND FORECLOSURES
Questions and Answers on Home Foreclosure and Debt Cancelation
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Click here for most recent approved shortsales guidlines effective April 2010 Updated Dec This provision applies to debt forgiven in 2007, 2008 or 2009. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if single or married filing separately). The exclusion doesn’t apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition. The amount excluded from income reduces the taxpayer’s cost basis in the home. The basis of your hone is generally the cost of the home plus any improvements you made to it during the time you owned it less depreciation if applicable. Principal residence is the home in which you live and you may have only one main residence at a time. All other properties do not qualify as principal residence. TIP: Canceled debt income may still be excluded on investment or business property if other provisions apply such as, title 11 bankruptcy or financial insolvency. Financial insolvency is the provision mostly ignored by tax payers. If you apply for this exclusion, make sure you keep records to prove that you were financial insolvent immediately before the debt was canceled or forgiven. TIP: while losses on personal residence are not deductible, losses on business or income producing property may be deductible against other income. Because this a Real Estate web page most of the information contained will be related to provisions that affect real estate transactions such us short sales, foreclosures, repossessions, abandonments, adn loan modifications. LOAN MODIFICATIONS AND WORK OUTS On of the most popular transactions in real estate refinancing in 2008 and part of 2009 will be loan modifications. If a debt is reduced by the lender, the amount of debt reduced must be reduced from the basis of your home and the canceled debt exclusion must be reported on form 982. Debt forgiveness by a seller on an owner financed purchase that is later reduced in a work out or loan modification and is not due to bankruptcy or financial insolvency is not treated as canceled debt, however the amount of debt forgiven must be reduced from the basis of the subject property. Interest rate modifications or other terms that do not reduce the principal amount of the debt are not considered debt forgiven es or canceled debt income.
The questions and answers, below, are based on the law prior to the passage of the Mortgage Forgiveness Debt Relief Act of 2007. 1. What is Cancelation of Debt? If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the canceled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancelation of Debt. Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancelations of debt of $8,000, which generally is taxable income to you. 2. Is Cancelation of Debt income always taxable? Not always. There are some exceptions. The most common situations when cancelations of debt income is not taxable involve:
3. I lost my home through foreclosure. Are there tax consequences? There are two possible consequences you must consider:
Use the following steps to compute the income to be reported from a foreclosure: Step 1 -For non-recourse loans, skip this section. You have no income from cancelations of debt.) (Note: Figuring Cancelation of Debt Income ___________3. Subtract line 2 from line 1.If less than zero, enter zero. The amount on line 3 will generally equal the amount shown in Step 2 – Figuring Gain from Foreclosure The amount on line 6 is your gain from the foreclosure of your home. If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income. If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.
No. Losses from the sale or foreclosure of personal property are not deductible.
A borrower bought a home in August 2005 and lived in it until it was taken through foreclosure in September 2007. The original purchase price was $170,000, the home is worth $200,000 at foreclosure, and the mortgage debt canceled at foreclosure is $220,000. At the time of the foreclosure, the borrower is insolvent, with liabilities (mortgage, credit cards, car loans and other debts) totaling $250,000 and assets totaling $230,000. The borrower figures income from the foreclosure as follows: Use the following steps to compute the income to be reported from a foreclosure: Step 1 -For non-recourse loans, skip this section. You have no income from cancelations of debt.) (Note: Figuring Cancelation of Debt Income 3. Subtract line 2 from line 1.If less than zero, enter zero.___$20,000__ The amount on line 3 will generally equal the amount shown in Step 2 – Figuring Gain from Foreclosure __$30,000__6. Subtract line 5 from line 4.If less than zero, enter zero. The amount on line 6 is your gain from the foreclosure of your home. If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income. If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses. In this situation, the borrower has a tax-free home-sale gain of $30,000 ($200,000 minus $170,000), because they owned and lived in their home as a principal residence for at least two years. Ordinarily, the borrower would also have taxable debt-forgiveness income of $20,000 ($220,000 minus $200,000). But since the borrower’s liabilities exceed assets by $20,000 ($250,000 minus $230,000) there is no tax on the canceled debt. Other examples can be found in IRS Publication 544, Sales and Other Dispositions of Assets, under the section “Foreclosures and Repossessions”. 6. I don’t agree with the information on the Form 1099-C. What should I do? Contact the lender. The lender should issue a corrected form if the information is determined to be incorrect. Retain all records related to the purchase of your home and all related debt. 7. I received a notice from the IRS on this. What should I do? The IRS urges borrowers with questions to call the phone number shown on the notice. The IRS also urges borrowers who wind up owing additional tax and are unable to pay it in full to use the installment agreement form, normally included with the notice, to request a payment agreement with the agency.
You need to use IRS form 982 To report or exclude canceled debt income reported to you on 1099C forms by your lender or other financial institutions.
Armando N. Hurtado with Ace Tax and Realty is a licensed real estate broker and a registered tax preparer. The information here in is not constructed to be used as legal advice and shall not be used as such. For more detailed information please consult a professional in this field. |
