Archive for the ‘insolvency’ Tag
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.
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 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.
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