A CONCERN that is growing rapidly is the cancellation of mortgage foreclosures. Although these are leading causes, they are not the only ones; cancellation of debts could be from consumer debts, bank and finance companies as well.
For debt cancelled due to a mortgage debt, the option I would suggest homeowners to know about is the option to pursue a short sale on their property.
Generally, if a taxpayer owes a debt, and the person or business holder of the debt cancels or forgives it, the taxpayer must include the cancelled amount as income on their tax return. Cancelled debt is treated as income because the taxpayer received the benefit of the debt, but did not also carry the burden of repayment.
Both foreclosure and repossession are treated as a sale or exchange of the property and both may result in gain or loss for the buyer. In addition to gain or loss, the buyer may also realize income from cancellation of debt, if the unpaid balance of the loan is greater than the fair market value of the property, which is what is going on in our real estate market now.
Abandonment of Property occurs when the buyer voluntarily and permanently gives up possession and use of the property, with intention of ending their ownership, but without transferring ownership to anyone else. Typically called “Deed in Lieu of Foreclosure” if the buyer has a recourse debt (non purchase money) they may realize ordinary income if the debt is cancelled. On Non-Recourse debt cancelled, the buyer may have gain or loss, but not income.
Reminder: these are all information gathered to help you understand consequences of a cancellation of debt, to make certain you employ a tax professional come tax time to get your taxes properly filled. You will ask others for advice, but at the end of the day please listen to your Tax Professional.
When lenders cancels a debt of $600.00 or more, the entity is required to file Form 1099 C with the IRS, and send a copy to the buyer.
Now listen to this, INSOLVENCY: Income from the cancellation of debt may be excluded to the extent the buyer has negative net worth. The buyer has negative net worth when their liabilities exceed the fair market value of their assets, immediately before the cancellation of debt. Ask your CPA or go to IRS.gov and see if you can qualify for this, FORM 982 Reduction of Tax Attributes Due to Discharge of Indebtedness.
Why are you being advised to let your property go to Foreclosures instead of taking steps to do a short sale? Well, it really depends on who you are asking, this is what happens to recourse loans once it goes to foreclosure, the homeowners will receive a “Deficiency Judgment” once the property is sold thru foreclosure for the difference on what is owed, plus attorney fees, late penalty fees, commission and what the property sold for. Typically once there is such a judgment received the sellers have no way of paying that debt back that is why they got into that situation in the first place. So, they will be advised to file for Bankruptcy to get rid of that unsecured debt. Now, when you hire an agent to do a short sale on your property, you will always ask for debt forgiveness in order to avoid a Deficiency judgment. Due to the “Debt Relief Act of 2007” expiring the end of this year, your deficiency with your lender might have a consequence and you also will be subject to taxes on amount of debt unpaid. Please consult your tax attorney to be able to make sure you are aware of the laws that might help you and hurt you due to your mortgage deficiency.
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For further clarification of this process of dealing with lenders, call Ken Go at 1st Innovative Finance Group at (562) 697-7028 or write to: [email protected]