Foreclosures on the Rise

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1 That Pesky COD Karen Brosi, EA, CFP

2 Foreclosures 2

3 1 Foreclosures on the Rise Top 4 states at Sep 30, 2009: Nevada Arizona California Florida 2.5 million properties p received default notice first 9 months of million at risk in next 4 years 28% of home mortgages are underwater (Deutsche Bank)

4 2 IRS Help New Publication 4681 Worksheet for foreclosure Worksheet to determine insolvency FAQs at IRS.gov 5

5 2 IRS Collection Practice Eased Tax liens subordinate if refinance/sell 1. (IR ); Pub. 784 and Pub Discharge of IRS tax lien if mortgage exceeds sale 6

6 2 IRS Collection Practice Eased Collection efforts ease (IR ) 2) 1. Actions postponed 2. Flexibility if payments missed 3. OIC second review before rejection 4. Easing of OIC late payment penalties 5. Expedited dlevy release 7

7 4 Foreclosure Equals COD Income Reduction in debt is taxable as ordinary income Form 1099 A (foreclosure sale) Form 1099 C (loan reduced) Foreclosure Even a forced sale is a taxable sale Whether foreclosure, deed in lieu, mortgage workout or short sale 8

8 4 Foreclosure Equals COD Income Calculation is different if; Nonrecourse debt (not personally liable) Recourse debt (personally liable) 10

9 5 Foreclosures Basics Non recourse debt is treated like sales price at foreclosure No COD results In some states debt to buy a personal residence is non recourse AK, AZ, CA, CT, FL, ID, MN, NC, ND, TX, UT, WA But, be careful! A refinance may change status of dbt debt 11

10 6 Foreclosure Nonrecourse Debt $600,000 Adjusted Basis ($50,000) Loss Foreclosure Gain (Loss) $550,000 Sales Proceeds (Debt) 12

11 6 Foreclosures Basics Recourse debt must be bifurcated Amount of cancellation of debt & Gain/loss on sale COD income results Rfi Refi sare often recourse dbt debts 14

12 7 Foreclosure Recourse Debt $600,000 Adjusted Basis $500,000 Sales Proceeds (FMV) $550,000 Recourse Debt ($100,000) Loss Foreclosure Gain (Loss) $50,000 COD Income 15

13 8 Worksheet Calculates COD income for Foreclosures Repossessions 16

14 8 Property Type Matters Business, investment or personal determining Business = ordinary loss on sale Investment = capital loss on sale Personal = non deductible loss on sale 17

15 8 Foreclosure of Business Property 1. Calculate COD 1. Loan less FMV 2. Calculate gain or loss on sale 1. FMV at foreclosure is sales price 3. Character of gain or loss same as if property sold 18

16 9 Sharon Loses Las Vegas Rental Purchase Price $450,000 Acc. Dep. ($20,000) 1 st recourse mtg $400, FMV $250,000 COD Income $150,000 Sales Price $250,000 Adjusted Basis $430,000 Loss: Form 4797 ($180,000) 000) 19

17 9 Sharon Loses Las Vegas Rental COD equals loan less FMV $150,000 ordinary income Gain or loss equals FMV less adjusted basis of property lost $180,000 ordinary loss Net is $30,000 loss, the real loss

18 9 Property Acquired in Exchange Purchase Price $1,300,000, Deferred gain $200,000 Acc. Dep. ($125,000) 1 st recourse mtg $1,050,000 FMV $1,000,000 COD Income $50,000 Sales Price $1,000,000 Adjusted Basis $975,000 Gain: Form 4797 $25,000 21

19 9 Property Acquired in Exchange COD equals loan less FMV $50,000 ordinary income Gain or loss equals FMV less adjusted basis of property lost Basis was reduced by 1031 deferred gain $25,000 gain (depreciation recapture)

20 10 Project Lost in Foreclosure Sunnyvale Shopping Center LLC Construction in progress 10,000,000 Land 4,000,000 Assets 14,000,000 Mortgage 12,500,000 Equity 1,500, Liabilities and Equity 14,000,000 Foreclosed when FMV is $6,000,000, 23

21 10 Project Lost in Foreclosure Sunnyvale Shopping Center LLC Construction in progress 10,000,000 Land 4,000,000 Assets 14,000,000 Mortgage 12,500,000 Equity 1,500, Liabilities and Equity 14,000,000 Foreclosed when FMV is $6,000,000, COD $6,500, Loss $8,000,000 24

22 Short Sale Where the client sells the house for its FMV and after expenses, there is not enough to pay off the bank. If the short pay is forgiven by the bank, COD results (Stevens) And the bank will file a Form 1099C. 25

23 11 Exception to COD Income Rule Bankruptcy Insolvency 108 Farm debt for solvent farmer Seller financing If payment of liability would create dd deduction Discharge of real property business debt Reduce basis Bona fide dispute Qualified debt principal residence 27

24 Form

25 13 Insolvency Worksheet Taxpayer insolvent to extent liabilities exceed assets Includes house, pension, IRA, autos, furniture, tools, etc. How to calculate insolvency worksheet Pub

26 15 108: Qualified Farm Debt 1. If debt incurred in operating farm, and 2. 50% of receipts from farming last 3 yrs COD reduces basis. Not taxable income 31

27 15 108: Real Property Bus. Debt Debt to acquire, construct or improve real property used in a trade or business Elect to reduce basis instead of COD Relief can t exceed FMV Elect on Form 982 timely Late election only with IRS permission 32

28 18 Reduction of Tax Attributes For non taxable COD reduce tax attributes in the following order: 1.NOLs 2.General business credits 3.AMT Credits 4.Capital losses 5.Basis reduction 6.Passive activity losses 7.Foreign tax credits 34

29 18 Cancellation of Debt Relief 108(i) COD Relief ( 108(i))

30 18 COD Relief 108(i) Debt by debt election, year by year No other 108 provision will apply Reacquisition of debt in 2009 or 2010 Defer income until 2014 Include ratably in Irrevocable 36

31 19 COD Relief 108(i) Trade or business debt and all entities Partnership, not partner, makes election All forms of debt relief qualify Purchase Exchange Forgiveness Contribution of capital State law conformity? 37

32 21 Qualified Residence 38

33 Exclusion Bankruptcy Insolvency Farm debt for solvent farmer Seller financing If payment of liability would create deduction Discharge of real property p business debt Bona fide dispute NEW Qualifiedacquisitionindebtedness acquisition indebtedness on principal residence 39

34 21 Principal Residence Requirement #1: Qualified Principal Residence See $250,000/$500,000 exclusion of gain on sale of home rules for definition Not N tvacation home, rental tlor investment property 40

35 21 Qualified Home Acquisition Debt Requirement #2: Qualified Acquisition Original ii or refinanced db debt used for acquisition, construction or improvement of principal residence Secured by the principal residence Recourse debt under $2 million of acquisition debt 41

36 21 Qualified Home Acquisition Debt Relief Result Qualified Acquisition Debt Relief Excluded from Income See Form 982 Effective Jan. 1, 2007 through Dec. 31,

37 24 California Cancellation of Debt Partial conformity to federal mortgage forgiveness debt relief BUT ONLY FOR 2007 AND 2008 Imposes lower limits on qualified debt and debt relief

38 22 Only Part is Acquisition Debt Ordering rules are required if acquisition debt less than total debt relief Any forgiven home equity debt not used for improvements cannot be excluded 45

39 22 Only Part is Acquisition Debt Holly refinances her home and takes $200,000 from her home to pay off bills. At foreclosure, she ll pay tax on $200,000 COD unless she is insolvent 46

40 22 Example of Mortgage Modification Purchase price: $435,000 1 st recourse mortgage: $420,000 2 nd improvement mortgage: $30,000 Refi to $475,000 when 2 loans $440, FMV reduces to $425,000 & bank agrees to $40,000 mortgage modification What s excludable? $5,000

41 23 Checklist for Exclusion Must be principal residence Must be acquisition indebtedness Homeowner not bankrupt Homeowner not insolvent Cancellation is not for personal services

42 23 Excluding COD on Home Basis of home is reduced by the amount of excluded income Turns ordinary income back into capital gains 49

43 24 Excluding COD on Home Exclusion does not apply to a debtor in a bankruptcy case The exclusion due to bankruptcy applies Taxpayer may choose insolvency exclusion Mortgage workouts and short sales included New Form 982

44 24 Form

45 Sharon Kreider and Karen Brosi Hope to see you IN PERSON at the Western CPE 2-day California/Federal tax updates.

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