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| Tax Consulting on =
Short-Sales and=20
Foreclosures |
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Our law firm provides tax advisory services in =
calculating=20
the taxes owed from a foreclosure, short sale, =
surrender of=20
deed in lieu of foreclosure, and similar =
transactions.
We can assist in estimating the taxes due and the=20
pre-payment of those taxes, as well as determining if =
there is=20
some way to mitigate, offset, or defer the tax =
liability from=20
a failed real estate transaction.
Please call us at 949.200.7284 if you desire to be =
a client=20
of the firm, or send us an e-mail to questions =
<at>=20
risad.com |
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Tax =
Consequences of=20
Foreclosure,
Short Sale and Deed in Lieu of=20
Foreclosure
by =
Christopher M. Riser
Introduction
A distressed real =
property=20
owner facing the prospect of a foreclosure, short sale or =
deed in=20
lieu of foreclosure may be surprised to discover that these =
events=20
can lead to income taxation of capital gain or cancellation =
of=20
indebtedness (=E2=80=9CCOD=E2=80=9D) income. For =
purposes of this=20
article, I=E2=80=99ll use the term =E2=80=9Cdistressed =
property disposition=E2=80=9D to=20
refer to a foreclosure, short sale or deed in lieu of=20
foreclosure.
The tax results of =
a=20
distressed property disposition depend on whether the loan =
is a=20
=E2=80=9Crecourse=E2=80=9D loan or a =
=E2=80=9Cnon-recourse=E2=80=9D loan. =
If a lender=E2=80=99s sole option for =
recovering on the loan=20
is to take back the property, it is a non-recourse =
loan. =
The non-recourse aspect of a loan may be =
spelled out=20
in the loan documents, or it may be a matter of state law, =
as it=20
often is in the case of purchase-money loans and =
seller-financed=20
loans for owner-occupied residential property. =
If the lender can pursue the borrower =
personally for=20
any shortfall, it is a recourse loan. =
In situations where there is a shortfall on =
a recourse=20
loan, the lender is supposed to send the IRS and the =
borrower a form=20
1099-C reporting the borrower=E2=80=99s COD =
income.
Non-Recourse Loan Tax=20
Consequences
In the case of a =
distressed=20
property disposition with a non-recourse loan, the =
disposition is=20
taxed as if it were sold for the greater of the outstanding =
debt or=20
the sales price. The =
nature of the=20
gain and the deductibility of any loss depend on the holding =
period=20
and the nature of the property as with any other=20
disposition. The =
following=20
examples are simplified. Adjusted tax basis for calculating =
gains=20
and losses can be affected by more than just purchase price =
and=20
depreciation; and the deemed sales price in a disposition by =
a deed=20
in lieu of foreclosure includes past due interest, but may =
be offset=20
by a deduction for that interest.
Example #1 (Non-Recourse =
Loan)
Ann owes $500,000 =
on her=20
personal residence she bought for $700,000, which now has a =
market=20
value of $400,000. Ann is =
taxed on a=20
distressed disposition of the property as if she sold the =
property=20
for $500,000, and she has a personal loss of $200,000, which =
is not=20
deductible.
Example #2 (Non-Recourse =
Loan)
Bill owes =
$1,000,000 on his=20
personal residence he bought for $950,000, which now has a =
market=20
value of $1,050,000. Bill is =
taxed on a=20
distressed disposition of the property as if he sold the =
property=20
for $1,050,000, and he has a gain of $50,000, which may be=20
excludible from income if Bill meets the 2-year ownership =
and=20
residency test of IRC Sec. 121.
Example #3 (Non-Recourse =
Loan)
Carla owes =
$1,000,000 on a=20
commercial property she bought for $1,100,000, which is now =
worth=20
$800,000. =20
She has taken $200,000 in =
depreciation=20
deductions. Carla is =
taxed on a=20
distressed disposition of the property as if she sold the =
property=20
for $1,000,000. Carla is taxed as if she had sold the =
property for=20
$1,000,000, and she has taxable depreciation recapture of=20
$100,000.
Recourse Loan Tax=20
Consequences
For a loan to be =
treated as a=20
recourse loan, the lender must have the ability to pursue =
the=20
borrower personally under the terms of the loan document and =
under=20
state law. Generally, that=20
means that if the property brings the lender less than the=20
outstanding loan amount, the lender must obtain a =
=E2=80=9Cdeficiency=20
judgment.=E2=80=9D As a =
practical=20
matter, in many states, this often does not happen, because =
it=20
involves more legal work and usually does not pay off for=20
lenders. =20
However, don=E2=80=99t be =
surprised to see junk=20
debt collectors getting into this market, in which case, we =
may see=20
more deficiency judgments than in the past.
In the case of a distressed disposition =
of=20
property subject to a recourse loan, in addition to the =
potential=20
income and gain resulting from the sale for value, there =
also may be=20
COD income if the debt exceeds the value of the property. =
COD income=20
is taxed at ordinary income rates.
Example #4 (Recourse =
Loan)
Don owes $500,000 =
on his=20
personal residence he bought for $700,000, which now has a =
market=20
value of $400,000. He lives =
in a state=20
where lenders can pursue deficiency judgments against =
residential=20
borrowers. Don is taxed on a distressed disposition of the =
property=20
as if he sold the property for $500,000, and he has a loss =
of=20
$200,000, which is not deductible. =
He also has COD income of =
$100,000.
Example #5 (Recourse Loan)
Ethel owes =
$900,000, on a=20
recourse basis, on a luxury condo investment property she =
bought for=20
$1,000,000, which now has a market value of =
$600,000. =
She has taken $100,000 in depreciation=20
deductions. Ethel is =
taxed on a=20
distressed disposition of the property as if she sold the =
property=20
for $900,000. She has =
COD income=20
of $300,000, and a long-term capital loss of =
$300,000.
Example #6 (Recourse =
Loan)
Frank owes =
$2,000,000, on a=20
recourse basis, on a commercial property he bought for =
$500,000,=20
which now has a market value of $1,500,000. =
He has taken $200,000 in depreciation=20
deductions. Frank is =
taxed on a=20
distressed disposition of the property as if he sold the =
property=20
for $2,000,000. He has =
COD income of=20
$500,000, depreciation recapture of $200,000, and a =
long-term=20
capital gain of $1,000,000.
Exceptions to Taxability of COD=20
Income
COD income is not =
taxable if=20
the debt is discharged as part of a bankruptcy=20
proceeding. In =
addition, some or=20
all of the COD income may not taxable if you are insolvent =
at the=20
time the debt is cancelled. For =
example, if you=20
owns assets with a fair market value of $2,000,000 and has=20
liabilities of $2,250,000, only $250,000 (the amount by =
which he is=20
insolvent) can be excluded if the liabilities are =
discharged.=20
Determining insolvency for these purposes can be complex, =
and the=20
assistance of a tax professional likely will be required to =
make=20
this determination. However, the excluded COD income will =
reduce=20
other tax attributes such as basis, current and carryover =
losses,=20
etc. =20
So, COD income could still give =
rise to=20
additional tax, even if it is excluded from current=20
income.
There are also =
exceptions for=20
COD income arising from the cancellation of qualified farm=20
indebtedness and qualified business =
indebtedness. =
However, qualified business indebtedness =
likely will=20
not include loans for commercial or residential rental=20
property.
Example #7 (Insolvency)
Gina owes =
$3,000,000, on a=20
recourse basis, on a commercial property she bought for =
$1,000,000,=20
which now has a market value of $2,500,000. =
She has taken $300,000 in depreciation=20
deductions. She is =
taxed on a=20
distressed disposition of the property as if she sold the =
property=20
for $3,000,000. She has =
COD income=20
of $500,000. However, =
after the=20
discharge of the debt, she is solvent only by $200,000., so =
$300,000=20
of the $500,000 COD income is not taxable, and instead will =
reduce=20
other tax attributes, such as her $100,000 ordinary loss =
carryover=20
from last year. So, she =
has taxable=20
COD income of $200,000, depreciation recapture of $300,000, =
her=20
ordinary loss carryover is reduced by $100,000 to zero, and =
her=20
basis in the property is reduced by $200,000, so that she =
has a=20
long-term capital gain of $1,700,000.
Mortgage Forgiveness Debt Relief =
Act of=20
2007
Finally, in late =
2007,=20
Congress provided some relief from taxation of COD income in =
the=20
case of =E2=80=9CQualified Principal Residence =
Indebtedness.=E2=80=9D QPRI is a loan=20
secured by the principal residence used to acquire, =
construct or=20
substantially improve the residence. =
For refinances, this amount is capped at =
$2,000,000=20
($1,000,000 for a married person filing a separate=20
return).
Under the Mortgage =
Forgiveness=20
Debt Relief Act of 2007, IRC Sec. 108(a)(1)(E) was added and =
provides that for the period January 1, 2007 through =
December 31,=20
2009, COD income from QPRI is not taxed. =
However, it=E2=80=99s not a complete =
freebie. =
As with the insolvency exception, any =
reduction of=20
indebtedness under the QPRI exception will reduce the basis =
in the=20
property. =20
So, this could still give rise =
to capital=20
gain.
Example #8 (QPRI)
Harry and Helga =
owe $2,000,000=20
on their personal residence, which they bought several years =
ago for=20
$1,000,000, and which is now worth $1,500,000. =
They live in a state where lenders can =
pursue=20
deficiency judgments against residential =
borrowers. =
They are taxed on a distressed disposition =
of the=20
property in 2008 as if they sold the property for=20
$2,000,000. They =
have $500,000=20
of COD income, but it is not taxable. =
However, their basis is reduced by $500,000, =
so they=20
have a capital gain of $1,000,000, of which $500,000 is =
excludable=20
under IRC Sec. 121 as gain on the sale of a principal=20
residence. So, they =
will be=20
taxed on $500,000 of capital gain.
|
|
The All-Time =
Bestseller
on=20
Asset Protection Planning
by Jay Adkisson and Chris =
Riser |
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|
Asset =
Protection:
Concepts=20
& Strategies,
by =
Jay D.=20
Adkisson
and Christopher M. Riser |
| |
|
Available at
Amazon.com and Barnes=20
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Available at
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NEW CLIENTS
Those desiring to be clients of =
the firm=20
should call
949.200.7284
to schedule a brief free call with =
a partner=20
of the firm. We do not answer general questions by =
phone.=20
General questions directed to the firm should be =
e-mailed=20
to:
questions =20
>at< =20
risad.com |
To ensure compliance with requirements =
imposed by=20
the IRS in Circular 230, we must inform you that any tax =
advice on=20
this website is not intended or written to be used, and =
cannot be=20
used, for the purpose of (i) avoiding penalties under the =
Internal=20
Revenue Code; or (ii) promoting, marketing or recommending =
to=20
another party any transaction or other matter addressed=20
herein. |
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