Archive for the ‘cancellation of debt’ Tag

Relief if You Paid Tax on a Short-Sale 2011-2013

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.

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American Taxpayer Relief Act of 2012

Originally published in the Cedar Street Times

January 11, 2013

The American Taxpayer Relief Act of 2012 was signed into law January 2, 2013.  There was lots in the bill, but I am going to hit on a few that are notable and others that having meaning to a lot of people.  I think making the Alternative Minimum Tax patch permanent and indexed for inflation was a huge victory for many taxpayers.  That patch has been kicked down the road for years.  The indexing will certainly alleviate concerns of a similar problem down the road.  Many middle class people do not realize they were on the cusp of paying thousands of dollars more on their 2012 tax returns due in April without this fix.

The estate tax exemption being set permanently at $5 million and also indexed for inflation is huge, especially for Californians that own property.  In a lot of ways, this simplifies estate planning for most individuals and will bring into question the need of the typical A-B split for many people that currently have it.  Having a B trust, or bypass trust, would require additional tax work in the future, so the ability to eliminate it, could be worth the cost of amending your trust.  Family dynamics may of course still dictate a B trust is prudent.

Various other temporary provisions we have been enjoying that were made permanent included marriage penalty relief for joint filers, better rules for student loan interest deductions and dependent care credit rules.

Quite a few things were extended but not made permanent.  A big one was extending the exclusion from income of cancelled debt on personal residences for another year.  This could be a lifesaver for those still struggling with mortgages that are “underwater.”  Deductions for grade school teacher expenses and an above-the-line deduction for qualified tuition and related expenses were other items extended through 2013.  More important than the deduction for tuition was the extension of the American opportunity tax credit through 2018 which saves taxpayers up to $2,500 each year as a result of education costs.  Enhanced provisions of the child tax credit were also extended through 2018.

Small businesses have had the luxury of writing off high dollar amounts of many capital asset purchases through code section 179.  This was slated to return to $25,000, but has been extended through 2013 at $500,000.  Bonus depreciation and accelerated expensing of qualified leasehold, restaurant and retail improvements on a 15 year schedule instead of returning to a 39.5 year schedule was also extended.

Bush-era tax rates and capital gains rates have been retained for everyone but the wealthy.  For people making over $400,000, their marginal bracket rose from 35% to 39.6%, and their capital gains tax went from 15% to 20%.  There is also a new 3.8% medicare tax on investment income for people generally making over $200,000 and a new hospital insurance tax of .9% for people generally making over $200,000.  Itemized deduction phaseouts have also returned for high income earners.

Everyday wage earners will be negatively impacted by the return of a 6.2% tax for Social Security rather than 4.2% tax we have had for the past two years, as they will see two percent less in their paychecks as a result.  Another negative impact for people with high uninsured medical expenses, is that the threshold for medical itemized deductions has moved from 7.5% of your adjusted gross income to 10%.  Individuals 65 and up will still enjoy the 7.5% rate for another three years.

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.

Short-Sale: Effects of CA Senate Bills 931 and 458

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 I – Overview

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.