Archive for the ‘Foreclosures and Short-Sales’ Category
Relief if You Paid Tax on a Short-Sale 2011-2013
Filed under: Foreclosures and Short-Sales, Residence Sale | Tags: 580(b), 580e, anti-deficiency, Barbara Boxer, California, cancellation of debt, Chief Counsel, debt, exclusion, Foreclosure, Franchise Tax Board, FTB, Internal Revenue Service, IRS, nonrecourse, principal residence, qualified debt, qualified principal residence indebtedness, recourse, refund, section 121, Senate bill 458, Senate bill 931, Short-Sale
Leave a comment Originally published in the Cedar Street Times
February 21, 2014
Hopefully we are nearing the end of the short-sale and foreclosure saga that has continued since 2008. My litmus test based on tax return filings is indicating that things are much closer to being back on track. Prior to 2008, it was all about 1031 exchanges. Those turned off like a faucet when the markets crashed, and then short-sales and foreclosures took center stage. I have seen those tapering off over the last couple years, and I am starting to see 1031 exchanges again. The cycles continue!
But before we leave short-sales and foreclosures in the dust, there is a possible silver-lining handed down by the IRS and FTB in the last few months. Taxpayers that generated income tax as a result of a short-sale in California on their principal residence, retroactive to January 1, 2011, may be entitled to a refund.
California Code of Civil Procedure Section 580b has been dubbed California’s “anti-deficiency laws” for years. It had a positive effect on homeowners because it basically said if you had never refinanced your home and you lost it in a short-sale or foreclosure that you could not be pursued for the balance you still owed (the deficiency), and the remaining debt would not be taxable income to you because the debt was considered nonrecourse debt.
This, however, left many people out in the cold that had refinanced. Suddenly, it was a different ball game if you had done a refinance (and who didn’t during the run of good years up through 2007!?), and the debts were then allowed by lenders to be treated as recourse debts and they could pursue your personal assets. Alternatively they could cancel the debt if it was not worth pursuing, leaving you with taxable income for the amount cancelled.
Congress stepped in (and California generally conformed) during the housing crisis and enacted favorable legislation which said you could exclude cancellation of debt income generated by your personal residence. The catch, however, was that the debt had to be “qualified debt.” In short, if you lived off the equity in your house by refinancing to pull cash out and did anything with it other than improve the property, then you were not eligible for the exclusion on that portion and would still have to pay tax.
Then, a few years ago, California passed Senate bills 931 and 458 which were codified into law as California Code of Civil Procedure Section 580e as of January 1, 2011. This resulted because some unscrupulous lenders were entering into short-sale agreements to allow sellers to go through with the sale of their property for less than the amount owed to the bank, but then still pursuing the seller for the remaining debt after the fact (often a big surprise to the seller). California’s enactment of this law was good news for homeowners because it basically said, even if you had refinanced, but had entered into a short-sale agreement with a lender, then you could not be pursued for the remaining balance owed and that lenders would basically have to cancel the debt. Of course, cancelling the debt could mean tax was owed, but that was still better than being pursued for the remaining balance!
Finally, in November 2013 a letter from the Office of the Chief Counsel at the IRS written to Senator Barbara Boxer, due to an inquiry from her, stated that the IRS would treat any debt pursuant to California’s 580e as nonrecourse debt! The Chief Counsel’s office at California’s Franchise Tax Board followed up with their own letter a month later saying they will conform to the IRS interpretation.
This means that anyone who filed a tax return in 2011 or 2012, or even this year, and reported cancellation of debt income related to the short sale of a principal residence, should consider filing an amendment for a possible refund. It is still possible to have income tax, primarily if you did not live in the house for two of the last five years prior to your short-sale. The reason is that when a home is disposed of with nonrecourse debt, the total amount of debt outstanding at the time of the short-sale becomes the sales price of the home. You then subtract your cost basis, and the difference is your gain on sale. However, if you lived in the home for two of the last five years, then you get a $250,000 gain exclusion for filing as a single status, and $500,000 gain exclusion if married filing jointly, pursuant to IRC Section 121.
You need to act on this during the next year if your short sale was in 2011 as the statute of limitations expires three years after filing.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Losing Your Home? Favorable Tax Provisions Expire 12/31/12.
Filed under: Foreclosures and Short-Sales | Tags: 1099-C, cancelled debt, Foreclosure, FTB, insolvency, IRS, qualified principal residence indebtedness, recourse, section 108, Short-Sale
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
May 16, 2012
If you think you may not be able or willing to hold on to your home for the long-term, you should seriously consider your options for short sale or foreclosure as soon as possible. At the end of this year, Internal Revenue Code Section 108(a)(1)(E) is set to expire (California tax law conforms to the expiration also). This is the provision that allows people to possibly exclude from income, cancelled debt when recourse loans on their primary residence are higher than the value of the home. These transactions take three to 12 months to complete, so time is of the essence.
Between foreclosures and short sales, short sales are your best option in this regard. This is where you find a buyer and the lender accepts the buyer’s offer, even though it is less than what you owe the lender. Current law in California forces lenders to cancel the remaining debt as of the date of the short sale and prohibits them from pursuing your personal assets if they agree to the short sale. A foreclosure does not guarantee the lender will not pursue you for the remaining debt. Even if they do decide to cancel the debt, it may not be until after the end of this year.
Whether debt is cancelled by short sale or possibly by foreclosure, the cancelled debt is potentially taxable income to you. If you did not take cash out during past refinances, or to the extent you put cash-out back into improving the property, you will likely be able to exclude the cancelled debt income from your taxable income due to code section 108(a)(1)(E)…until the end of this year. After that, you will likely only be able to exclude the debt if, and only to the extent you are insolvent (more liabilities than assets). Bankruptcy is another option, but it must be filed before you lose the property – in other words, plan early.
Imagine $200,000 of income on your tax returns from cancelled debt, generating an extra $75,000 or more of tax. Many people will find these transactions to be the largest potentially taxable transactions in their life, so it is important to seek competent professional advice, plan appropriately, and avoid the tax if at all possible.
Prior articles relating to foreclosures and short sales are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Short-Sale: Effects of CA Senate Bills 931 and 458
Filed under: Foreclosures and Short-Sales | Tags: 1099-C, 580e, anti-deficiency, cancellation of debt, cancelled debt, deficiency, junior lien holder, recourse, SB 458, SB 931, Short-Sale
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
March 21, 2012
This past summer I wrote a series of six articles on short-sales and foreclosures. I am still receiving calls/e-mails from people all over California that have seen the articles republished on my website. One caller, a bankruptcy attorney from the Sacramento area, thought that an article addressing California Senate Bills (SB) 931, effective January 2011, and SB 458, effective July 2011, would be helpful.
Prior to these bills, there were cases where a lender would agree to a short-sale and the homeowner would give the home back thinking the remaining recourse debt was cancelled. Later, they would find the lender was still pursuing them for the deficiency and that the papers they signed did not actually cancel the remaining debt. SB 931 partly addressed this by not allowing the primary lender to pursue you for the deficiency once they agreed to a short-sale.
The problem then arose that junior lien holders such as a second loan or HELOC would continue to pursue the owner for the deficiency on their loan because the bill did not require them to cancel their remaining debt. Hence the passage of SB 458 which does not allow them to pursue the deficiency either. These bills have now both been codified into law in California Code of Civil Procedure Section 580e.
It is clearly good news that you will not be pursued for the debt, but you will still have a wrestling match with the taxing authorities. The new law requires the lenders to accept the settled amount as payment in full and to fully discharge the remaining amount of indebtedness. Since the lender will be getting a tax deduction for your bad debt, you will be getting a 1099-C and will have taxable income unless you can exclude a portion or all of the debt under the provisions in Internal Revenue Code Section 108 and related Treasury Regulations.
The new law makes junior lien holders less willing to accept a short-sale, since they are often giving up their right of pursuit and get very little out of the deal. Kristin DeMaria, a short-sale attorney with Mallery & DeMaria PC in Monterey said, “Under this new law, the junior lien holders can no longer ask the sellers for money, but they can say no to the short-sale. The sellers, however, can voluntarily offer money and may want to do so to avoid pursuit for the full deficiency after a foreclosure on a recourse second loan.”
For tax purposes, it is highly important that you file a timely tax return with the correct forms, statements and calculations, otherwise you will unknowingly waive your right to any possible discharge of cancelled debt to which you may be entitled. Having an attorney and a CPA that specialize in the respective negotiation and tax issues is key to navigating these waters successfully.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part VI – Rental Properties
Filed under: Foreclosures and Short-Sales | Tags: cancelled debt, Foreclosure, qualified real property business indebtedness, recourse, rental properties, Short-Sale
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
September 7, 2011
The last five issues I went over the basic concepts of foreclosures and short-sales, an overview of ways to exclude the resulting taxable income, the effects of recourse/nonrecourse debt, and principal residence and insolvency exclusions. If you missed these articles they are re-published on my website at www.tlongcpa.com/blog. This issue I will specifically discuss the exclusion typically available for rental properties.
When someone loses real property through short-sale or foreclosure, potential taxable income can result since recourse cancelled debt is taxable income. As I have discussed in prior issues, there may be ways to exclude this income on the tax return. With solid, early planning, we may be able to even change the characteristic of a property and drive the outcome to the most tax favorable result should a short-sale or foreclosure occur. All or part of the cancellation of debt income associated with losing a rental property may qualify for the Qualified Real Property Business Indebtedness exclusion assuming you are not going through a bankruptcy and you are not insolvent, in which case other exclusions take precedence. Another key issue is whether or not a rental property is a business. This concept is requisite to use the exclusion. The courts have a long history of upholding this construct, but the IRS does not always agree, and it comes down to facts and circumstances.
Notice the word, “Qualified,” in the name of the exclusion. This is a subtle hint that certain criteria must be met to receive this treatment, and is sometimes misunderstood by preparers not well-versed in the governing code sections. As with other exclusions discussed in past articles, the cancelled debt must have been used to purchase or construct the property, additions, remodels, etc. If you borrowed against the equity in the property to finance your personal life or to purchase or renovate another property, that portion will not qualify for the exclusion. There are also limitations on the amount of income that can be excluded relating to the fair market value of the property, basis in depreciable property, and other factors.
The amount determined to be excludable then becomes a reduction of your cost basis in the property (the timing and calculation of this basis reduction is affected by several other factors as well). This is important, because we also have to calculate a gain or loss when you dispose of the property, and yes, in ugly situations, you can have a gain on sale even if you owe a lot more than the property is worth. Ouch! For example, ignoring transaction costs, depreciation, loan payments, etc., assume you bought a property for $250K, refinanced and took another $400K out to live-on as the property value soared to $750K and now it is only worth $350K and is foreclosed. You have $300K ($650K Debt – $350K Value) of cancelled debt and a taxable gain of $100K ($350K Value – $250K Cost).
When handling one of these transactions, it is a bifurcated process whereby we handle the cancellation of debt issue on the one hand, and the gain/loss calculation on the other. The two dance a bit, but are generally separate calculations. The beauty of rental properties, unlike personal residences, is if a loss is generated, it may be deductible, whereas, losses created by the disposition of personal residences are nondeductible. This is where planning comes in to play.
This is just a summary of some of the key provisions. There are many other circumstances and specific rules that could affect you, and you need to consult with a qualified professional to review your situation. Consult as soon as you can foresee the possibility of losing a home in order to plan the most tax efficient way to lose it.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part V – Insolvency
Filed under: Foreclosures and Short-Sales | Tags: basis reduction, cancelled debt, carryovers, Foreclosure, foreign tax credits, general business credits, insolvency, net operating losses, nonrecourse, passive activity losses, recourse, Short-Sale, tax attributes
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
August 17, 2011
The last four issues I went over the basic concepts of foreclosures and short-sales, an overview of ways to exclude the resulting taxable income, the effects of recourse/nonrecourse debt, and the principal residence exclusion. If you missed these articles they are re-published on my website at www.tlongcpa.com/blog. This issue I will specifically discuss the exclusion available when you are insolvent.
Insolvency means your liabilities are greater than the fair market value of your assets – essentially you have a negative net worth. In such cases, the IRS may allow you to exclude cancellation of debt income, created as a result of losing a home or rental property, to the extent that you are insolvent. This insolvency calculation is performed based on your assets and liabilities the moment before your debts are discharged.
Let us assume you are losing a second home with recourse loans so the principal residence exclusion does not apply to you. You have a house worth $300,000 and the value of everything else you own – cars, savings, retirement plans, household items, etc. is $100,000 for a total of $400,000 in assets. Then assume your home loan was $550,000 and you have you have $50,000 in credit card debt and car loans for a total of $600,000 in liabilities. You are insolvent by $200,000. If your home was foreclosed, you would have cancellation of debt income of about $250,000. You can exclude $200,000 of the $250,000, from income, leaving you with only $50,000 of taxable income.
When calculating your insolvency, do not forget to include the fair market value of pension plans, annuities, etc. If you have a plan such as CalPers, for instance, that pays you a monthly retirement benefit, you need to call your plan administrator and ask for an actuarial calculation of the value of your plan. Some people are surprised to learn that that pension can easily be worth $500,000 or $1,000,000, and would drastically change your insolvency calculation!
After determining how much debt can be excluded, you then have to reduce any tax attributes you may have. In exchange for excluding the $200,000 of income as in the above example, you then have to reduce or eliminate tax benefits that may have been useful to you in the future, or defer tax to a later date through basis reductions in items you may sell later. There is a specific order, method, and timing for doing this, but items such as carryovers of net operating losses, general business credits, minimum tax credits, and capital losses; basis in depreciable and nondepreciable property; passive activity loss carryovers and foreign tax credit carryovers are all on the chopping block. If after all these rules are applied and you still haven’t traded enough to equal your exclusion, then you are off the hook!
Oh, and you still have to calculate the gain or loss on the disposition of the property. We will not discuss that in this issue.
It is possible for the insolvency exclusion to be used in conjunction with other exclusions, and there are ordering rules to the exclusions themselves. This is just a summary of some of the key provisions. There are many other circumstances and specific rules that could affect you, and you need to consult with a qualified professional to review your situation. Consult as soon as you can foresee the possibility of losing a home in order to plan the most tax efficient way to lose it.
If this exclusion does not help you completely, and you are losing a rental property, you may be eligible for the qualified real property business indebtedness exclusion – next issue’s topic!
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part IV – Primary Residence
Filed under: Foreclosures and Short-Sales | Tags: Foreclosure, Mortgage Foregiveness Debt Relief Act, nondeductible personal loss, primary residence, qualified principal residence indebtedness, section 108, section 121, Short-Sale
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
August 3, 2011
The last three issues I went over the basic concepts of foreclosures and short-sales, an overview of ways to exclude the resulting taxable income, and the effects of recourse/nonrecourse debt. If you missed these articles they are re-published on my website at www.tlongcpa.com/blog. This issue I will specifically discuss the exclusion available to people losing a principal residence.
Due to the tsunami of defaults anticipated when the markets began to fall in late 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act on December 20, 2007 which resulted in an additional exclusion in IRS Code Section 108 trying to help people going through short-sales, foreclosures, or mortgage reductions on a principal residence. There is a lot of incomplete and incorrect tax advice that floats around regarding this exclusion – not only from water-cooler talk and media blurbs, but from ill-trained tax preparers as well.
As discussed in my previous articles, cancelled debt on recourse loans is taxable income to you. The Qualified Principal Residence Indebtedness exclusion allows you to exclude the resulting income if the home was your principal residence (you can only have one and it is determined by facts and circumstances) subject to limitations. One of the common oversights is not understanding that only “qualified” debt is eligible for the exclusion. Generally speaking, this is the original debt to purchase or construct the property as well as debt subsequently obtained to improve the property (such as additions or remodels). If you refinanced your home to get cash out, and used the money for a new car, vacations, for a down payment on another home or rental property, education, to pay down other debts, or to pay your living expenses or even the mortgage on your home, or anything else – none of this is qualified for the exclusion. Yikes! In addition there are different Federal and California limits for how much qualified debt you can exclude. Any amount you cannot exclude will be taxable as ordinary income to you unless you can qualify for another exclusion.
Any amount you can exclude reduces your cost basis in the home. When the home is sold or the bank forecloses, you also have to calculate your gain or loss on the disposition. If you bought the home shortly before prices fell significantly, chances are that even with the basis reduction, the sales price will be less than your cost basis resulting in a nondeductible personal loss. (In a foreclosure the “sales price” is the fair market value of the home when foreclosed.) In cases where the calculation results in a gain, you may be able to exclude the gain, or part of the gain per Section 121, if you lived in the home for two out of the last five years.
If your loan was nonrecourse, you do not have cancellation of debt income, but you still have to calculate the gain/loss on disposition. Unfortunately, the “sales price” in these cases is the amount of debt outstanding when the home was disposed – and not the low, actual sales price (or fair market value if foreclosed). This can create taxable gains, but Section 121 may help you here as well.
This is just a summary. There are many other circumstances and specific rules that could affect you, and you need to consult with a qualified professional to review your situation. Consult as soon as you can foresee the possibility of losing a home in order to plan the most tax efficient way to lose it.
If this exclusion does not help you completely, you may be eligible for the insolvency exclusion – next issue’s topic!
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part III – Recourse and Nonrecourse Debt
Filed under: Foreclosures and Short-Sales | Tags: 1099-A, 1099-C, 580(b), anti-deficiency, Foreclosure, nonrecourse, recourse, refinanced, Short-Sale
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
July 20, 2011
The last two issues I went over the basic concepts of foreclosures, short-sales, and an overview of excluding the related income and what you give up in return. If you missed these articles they are re-published on my website at www.tlongcpa.com/blog. This issue I was intending to discuss the exclusion available to people losing their principal residence, but I am going to bump that to the next issue in order to cover one other fundamental concept – recourse and nonrecourse debt.
Recourse debt means that you are personally liable for the debt and the lender has the right to pursue you for the full balance of what you owe if the home is not enough to satisfy the debt you owe. Nonrecourse debt means the lender has agreed, in event of default, to take the house as full settlement for the debt, and they cannot pursue you for the amount you are deficient. This effectively means there is no debt for them to cancel, which means you can have no taxable income from cancelled debt. Clearly, you hope your debt is nonrecourse! How do you know?
Actually, if you have never refinanced your property, it is almost certainly nonrecourse. Hooray! This is due to the California anti-deficiency laws in California Code of Civil Procedures Section 580(b) which essentially makes it illegal for lenders to pursue borrowers for a deficiency on original purchase loans. Unfortunately these same provisions do not apply if you refinanced, and you will almost always find those loans to be recourse. Un-hooray.
Even with a recourse loan, it is rare to hear of lenders pursuing the deficiency because they do not find it particularly cost effective (think legal fees) or good press to sue someone who just lost a home and has a family to support with no job. It is often simpler for the lender to cancel the debt, take a loss, and write-it off as a bad debt on their tax returns.
There are two tax documents you may receive in the process of losing a property through foreclosure or short-sale. A 1099-A is a tax notification that you have given up or “A”bandoned the property. The other document is a 1099-C which should be issued if the lender “C”ancels a recourse debt. Both of these include the lender’s idea of its fair market value and if you are personally liable. Both are notoriously incorrect assuming you receive them at all. The 1099-C also includes the amount of debt you owed when cancelled. A savvy tax professional will recognize these issues can affect your taxes and will help you take appropriate action. If you have a foreclosure or short-sale looming, get help early.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part II – Exclusions from Income
Filed under: Foreclosures and Short-Sales | Tags: bankruptcy, cancelled debt, Foreclosure, insolvency, qualified farm indebtedness, qualified principal residence indebtedness, qualified real property business indebtedness, section 108, Short-Sale, tax attributes
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
July 6, 2011
In the last issue I went over the basic concepts of foreclosures and short-sales and explained that your debt forgiven in these transactions is considered taxable income. It is difficult to face a tax bill in congruence with losing a property so Congress provided some options to possibly exclude the cancelled debt from your taxable income.
Section 108 of the Internal Revenue Code will likely be your hero. This code section and its related code sections and regulations are not for the faint of heart as I have witnessed by the glazed eyes of a sea of tax professionals trying to grasp the nuances in the rules, as well as phone calls I have received from other CPAs and attorneys.
Based on my experience with over 80 of these transactions, if you distill the mess of complex code down to its core, you will find after the dust settles and the house is gone, if you truly have nothing left, you will typically get off the tax hook. For everyone else, to the extent you have a positive net worth or future tax benefits, these code sections swallow your benefits or act as a deferral of tax to a later date – do not be misled, however, this is still a great stamp in your passport (summer cliché). To receive these benefits, however, you have to apply the code and file the forms and additional statements correctly with an original, timely filed return. If you foresee the future chance of losing a property, consult early to strategize how to best “lose the property” – it may save you a lot of money.
Section 108 covers all discharges of debt, but I will focus on it from the perspective of debts discharged due to the loss of a home or rental property. The circumstances that may qualify you to exclude the debt or part of the debt from income are: bankruptcy, insolvency (you have more liabilities than assets), qualified farm indebtedness, qualified real property business indebtedness (typically rental property debt falls here), and qualified principal residence indebtedness (debt on your main home usually qualifies here). You see the word qualified in a number of these exclusions because not all debt is eligible. The escape hatch may get smaller, for instance, if you lived off the equity of your home and did not reinvest refinance proceeds back into improving it.
Once it is determined how much debt can be excluded from income (which can come from a combination of exclusions), we then apply tax attribute reduction rules – on the chopping block include items that could have saved you tax in the future: net operating losses, general business credits, minimum tax credits, capital loss carryovers, tax basis in your other assets (most people have at least some of this), passive activity loss and credit carryovers, and foreign tax credit carryovers. The order, timing, and calculation of these rules are different depending on which of the previously mentioned exclusions you are using. Next issue, I will focus on the principal residence exclusion.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part I – Overview
Filed under: Foreclosures and Short-Sales | Tags: cancellation of debt, cancelled debt, COD, credit scores, deed-in-lieu, Foreclosure, Short-Sale, taxable income
Leave a comment Originally published in the Pacific Grove Hometown Bulletin
June 15, 2011
Over the past three years I have been involved with approximately 80 foreclosures and short-sales. Ultimately, it is a combination of strong tax and legal advice that will help you safely navigate these troubled waters. The stakes are high, the rules are complex, and we have no roadmap for future audits on these transactions. The common thread I have seen is that each foreclosure or short-sale is surprisingly unique and there is no one-size-fits-all approach to handling them successfully. Let’s start with an overview…
In a foreclosure, you stop paying the loan and the bank eventually repossesses the home and sells it. In a short-sale, you find a buyer, but the buyer will not offer enough for you to pay off the loan you owe. So you go to the bank and say, “Hey, I found someone willing to pay this much. I know it is short of the amount I owe you, but will you let the sale proceed, and let me off the hook for the rest?” These processes can take anywhere from three to 15 months from my experience, and in the end, most short-sales fail to materialize. Another animal, deed -in-lieu of foreclosure, is where you voluntarily give the home back to the bank in exchange for cancelling your debt obligation. A deed-in-lieu of foreclosure is rarely seen in California (zero out of my 80) because it does not absolve the bank of the junior lien holders on the property. Liens can be tricky to find and the bank does not want to get stuck with your other debts.
I am often asked which is better for credit scores and future ability to buy a home. I cannot tell you for sure – it depends on a lot of factors, but generally I think a short-sale is better for a lot of people (not all). Whether it is a short-sale or foreclosure, credit scores will be impacted significantly – maybe 200-300 points. With credit counseling you can typically rebuild it substantially in two to three years. Your future ability to buy a home will often depend on the loan program (FHA, VA, conforming loan, jumbo, etc.) and how much money you can put down. At this point, the best advice is to plan on three to seven years for foreclosures and two to seven years for short-sales (although I have heard less). Given the vast number of people losing their homes, I tend to think banks will become more lenient than in the past. I also think they will reward people who worked to accomplish a short-sale.
From a tax perspective, the big problem with these transactions is that they can create potentially taxable income…and a lot of it! The reason for this is quite simple – by cancelling your debt, the bank effectively gave you money to pay off your loan. Just as lottery winnings are taxable, so is debt that is cancelled. Fortunately, the IRC also contains sections which allow you to exclude the income. Next issue I will start discussing your tax options.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Travis H. Long, CPA, Inc. Blog 