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| | Author | Messages | |
Bridog
Posts:51
 | | 03/30/2008 7:41 PM |
 Alert | Courtesy of Realtor.com Loan forgiveness
After the Short Sale: Taxing What Isn't There
Too often, real estate practitioners are unaware of the tax liabilities arising from the cancellation of debt and fail to advise their clients accordingly.
BY LANCE CHURCHILL
You’ve just spent several stressful weeks helping your beleaguered seller negotiate a short sale. You’ve helped demonstrate to the lender that the home’s price has fallen and that to close the deal with the new buyer, the lender will have to forgive $10,000 of the seller’s outstanding mortgage loan not covered by the sale proceeds. But you did it, and now everyone is happy. The buyer gets a home, the lender avoids a messy foreclosure, and the seller walks away with no further financial burdens. Well, not quite.
Whenever real estate is sold, whether in a standard transaction, a short sale or a foreclosure auction, there are potential tax consequences for the seller. In this little scenario, the seller may still owe taxes to Uncle Sam — both in the form of capital gains on the home and on the unpaid portion of the mortgage. Yet, too often, real estate practitioners are unaware of the tax liabilities arising from the cancellation of debt and fail to advise their clients accordingly. Don’t make that mistake with your clients.
How Debt Forgiveness Works
With a short sale, the lender has three possible ways to handle the deficiency balance, which is the portion of the mortgage debt not covered by the sale of the home. First, the lender can attempt to collect the deficiency balance from the seller after the property has closed. Second, the lender may require the seller to sign an unsecured promissory note for the deficiency balance as a condition of agreeing to the short sale. If the new note is for less than the balance of the original debt, the difference would be considered canceled, or forgiven, debt. Third, the lender may agree to cancel the entire deficiency balance.
On the surface, option three would be seem to be the best alternative for a seller. However, the IRS considers any canceled mortgage debt ordinary income. This means that the amount forgiven is taxed at the same rate — somewhere between 15 percent and 30 percent — as the sellers’ salaries. In addition, because the IRS requires the lender to file a 1099-C form stating the amount of the canceled debt, Uncle Sam will have a record of the exact amount of the debt that was cancelled. A seller will also receive a copy of the 1099-C to use in filing income taxes. The seller’s home state would also consider the cancelled debt as ordinary income.
4 Exceptions to the Rule
The IRS does recognize four situations in which cancellation of debt will not result in tax liability for the seller. A seller may avoid tax liability:
- When the borrower receives a bankruptcy discharge and the deficiency was included in the bankruptcy
- When the borrower is insolvent at the time of the cancellation of the debt. Insolvency would occur when a borrower’s liabilities exceed assets. Note that seller would have to prove this insolvency to the IRS when filing a tax return.
- When the debt was secured by a nonrecourse loan. Under a nonrecourse loan, the lender does not have the legal right to collect a deficiency judgment from any assets of the debtor not pledged to secure the loan. While most home mortgages are do not fall into this category, purchase money loans on a person’s residence are nonrecourse in some states.
- When the tax liability from the cancellation of debt on an investment property can be offset against other business liabilities and expenses. This exception does not apply to properties occupied as a residence by the mortgagor.
In many short sales, a seller would be able to qualify under the first two of these exemptions, especially since it was almost certainly necessary to show financial hardship in order to convince the lender to agree to a short sale. However, it is the seller’s responsibility to notify the IRS why the amount in the 1099-C should not be counted as ordinary income. Otherwise, the IRS will consider the forgiven debt as income and penalize the seller for unpaid taxes.
What to Tell Clients
To ensure that your sellers don’t run afoul of the IRS and blame you, you should notify all sellers in writing that they should seek professional tax advice regarding the possible tax consequences of selling their home.
While you certainly don’t want to give specific tax advice, you should also alert short sellers to the basic facts about the tax consequences of short sales. With the current foreclosure crisis in this country, many, including NAR, are working to reverse this law. However, until that time, real estate sales associates must be aware of the potential tax issues for a seller in a short sale.
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| | AmyB1
Posts:457
| | 05/15/2008 1:12 PM |
Alert | You missed this good information..... Short Sale Tax InfoTax relief granted for forgiven debt, private mortgage insurance Bush administration allows three-year window Friday, December 21, 2007 By Matt Carter
Inman News President Bush signed into law Thursday a bill creating a temporary tax break for homeowners who are able to persuade lenders to forgive part of their debt, and extends a tax deduction for some families with private mortgage insurance. For the next three years, the IRS won't count as income debt forgiven by lenders when troubled borrowers negotiate short sales or workouts on their primary residence that involve forgiveness of part of their debt. HR 3648, the Mortgage Forgiveness Debt Relief Act of 2007, also extends for three years a tax deduction allowing families earning $109,000 or less to deduct all or part their private mortgage insurance premiums from their taxable income -- which could save them an average of $350 a year. In signing the bill, Bush said that not counting forgiven debt as income for tax purposes "will increase the incentive for borrowers and lenders to work together to refinance loans -- and it will allow American families to secure lower mortgage payments without facing higher taxes." Richard Gaylord, president of the National Association of Realtors, said NAR has been advocating for such a change to the IRS tax code for nearly 10 years. "We have always believed that it is clearly an issue of fairness and of not kicking people when they are down," Gaylord said in a statement. As originally passed by the House Oct. 4 in a 386-27 vote, HR 3648 would have made the exemption permanent, and extended the tax deduction for private mortgage insurance until 2014. But those steps would have eliminated about $2 billion in tax revenue over a 10-year period, a problem the bill sought to offset tightening the rules for claiming a deduction on the sale of a second home. The Bush administration argued that an exemption for forgiven debt should be temporary, and objected to provisions raising taxes on the sale of second homes. The Senate amended HR 3648 to address those concerns, and those changes were agreed to by House lawmakers in a Dec. 18 voice vote. The deduction for private mortgage insurance allows families with an adjusted gross income of $100,000 or less to deduct all of their premium payments. Families with incomes up to $109,000 are eligible for partial deductions. The private mortgage insurance deduction was first approved late in 2006 and initially applied only to the 2007 tax year. With the passage of HR 3648, the deduction has been extended to mortgages originated between 2007 and 2010. Extension of the tax deduction for mortgage insurance premiums was part of the Mortgage Forgiveness Debt Relief Act of 2007 approved earlier this month by both the U.S. House of Representatives and the U.S. Senate. Kevin Schneider, president of the Mortgage Insurance Companies of America (MICA), said borrowers who can claim the deduction could save an average of $350 a year. The cost of private mortgage insurance -- required by most lenders on loans with less than a 20 percent down payment -- is going up, as companies that provide it raise their rates in the face of mounting losses. PMI Group Inc. and MGIC Investment Corp. have raised or will soon raise rates for borrowers with lower credit scores and loan-to-value (LTVs) ratios above 95 percent. The companies have stopped insuring loans with LTVs above 95 percent for borrowers with credit scores below 620. MICA reports there was $790.5 billion in primary private mortgage insurance in force as of October, up 17 percent from $650.2 billion a year ago. The number of primary insurance defaults in October hit 59,308, up 28 percent from the same month a year ago.
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Senior Member: amyb
1800 or so posts
joined 2/21/2007 | |
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| | shannon77
Posts:44
| | 05/15/2008 3:47 PM |
Alert | What does all this mean in plain english? Isn't it still easier to foreclose? Are they going to make it harder to foreclose next year? Are the house prices really going to drop another 18%? Shannon | | | |
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| | LoriR
Posts:30
| | 05/15/2008 9:22 PM |
Alert | I'll try to explain it a little better. Let's just say you owe $200,000 on your home and need to sell it right now. The houses around you are probably selling for closer to $160,000 (just throwing out numbers, not real) So, you hire a realtor and they price your house somewhere around $160,000. You must prove that you are in a hardship situation (can't pay your mortgage anymore) and you are behind on it. You send your lender a packet of info (a letter, your last couple bank statements, bills, etc...) (again, different for every lender). At that same time, your house is being marketed.
Now, let's say Avg Joe comes and offers the asking price of $160,000. Now, you are fine with it. The bank (that you owe) then has to also accept the offer. They will send someone out to the property (called a BPO) who will estimate the value (not the same as an appraisal). Then the bank will decide yes, no or counter offer.
The reason the bank agrees to take the "short sale" is because they don't want the house back. If they get it back, most likely it will be trashed, then they have all the legal fees of getting it back, they have to pay a realtor to sell it, time wasted, etc, etc...
So, in this market, many lenders are taking less than what you owe them. It used to be that you could have tax consequences on the difference. So, you would add the $40,000 difference that the bank lost into your yearly income and pay taxes on it. Now, the president has passed a bill that relieves you of that tax. The only thing that will happen to you now is that your credit will go down somewhere between 80-100 points. Bad, but not as bad as a forclosure.
Hope this helps~! | | | |
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| | LeonPotter
Posts:354
| | 05/16/2008 6:35 AM |
Alert | I don't really think the new law will have a big overall impact. As noted in the original post, there WERE 4 exceptions to having to pay the tax. One could show INSOLVENCY before the new law.
The area where I believe it does help is the possibly the burden of proof by the taxpayer to the IRS to be exempt. Psychologically, I suppose, it would help reduce forclosure's because there is one less thing for the homeowner to consider to attempt a short sale instead of just "letting it go".
As for the lender, I believe the incentive remains the same.
To answer the question if it's easier to go let it go to foreclosure: I believe the answer is yes. | |
You may remember this from the original 85239:
Proverbs 22:7
The rich ruleth over the poor and the borrower is servant to the lender.
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| | Bridog
Posts:51
| | 05/22/2008 1:07 AM |
Alert | Lori makes some good points. The key is that the bank has to approve the offer. It isn't as easy as it sounds.
There has got to be a good reason that you can't make the payments: job transfer, adjusting mortgage, health etc..
The bad news is that banks aren't working very hard to ok shortsales.
Here is a breakdown at the homes sold in April:
Please keep in mind the number of Newbuilds is actually much higher, as many arent listed on the MLS
In April (Maricopa city)
136 homes sold
83 were bank owned (REO or forclosure)
14 were short sales
11 were resales
23 were spec homes sold by the builders
4 were corporate owned | | | |
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