Warning:

Do not pay up-front fees!

Loan Modification and Short Sale Companies are not authorized to charge up-front fees without an advanced fee agreement approved by the BRE.

 

SDHS does not

charge up-front fees.

 

Loan Modification fee is charged after modification is completed to the client’s approval.

Short Sale fee is paid for by the lender or buyer.

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Tax Implications

For a better understanding of the tax implications, debt forgivingness and possible lender pursuit of their loss, please reference all three sections:

 

Tax Implications     Judgments / Collections     Credit

 

2010 Update – California Mortgage Forgiveness Debt Relief

 

On April 12, 2010, SB 401, the Conformity Act of 2010 was enacted. It allows taxpayers who had all or part of the loan balance on their principal residence forgiven by their lender to exclude the forgiven debt from California gross income. The new law applies to discharges of qualified principal residence indebtedness on or after January 1, 2009, and before January 1, 2013.

 

http://www.ftb.ca.gov/aboutFTB/newsroom/Mortgage_Debt_Relief_Law.shtml or www.sandiegohousingsolutions.com/CADebtRelief2010.pdf

 

Four Step Tax Indebtedness Calculations

 

The tax implications for a given scenario for Loan Modification, Short Sale, Deed in Lieu or Foreclosure are similar because outcome depends on how property was acquired, financed, occupied and treated on tax returns.

 

One must first determine if the property is a Principal Residence and has Qualified Principal Residence Indebtedness. That is, at the time of the purchase, was it the intention to use that residence as a Principal Residence and was the indebtedness incurred in acquiring, constructing, or substantially improving the principal residence?

STEP ONE:

Determine if property is a Principal Residence with Qualified Principal Residence Indebtedness?

If the property qualifies as a Principal Residence and has Purchase Money Qualified Principal Residence Indebtedness then in the event of a foreclosure the loan is considered non-recourse money which is not subject to taxation or lender collection activity.

 

If the property is not a Principal Residence or does not have Qualified Principal Residence Indebtedness then the following sections describe how the IRS will calculate taxes.

 

There are two tax events that can result from the sale of property or loan modification.

(Federal and California tax rules/allowances are mostly alike)

  1. Income from Cancellation of Debt
  2. Income from Capital Gain on sale of property

 

I.  Taxable Gain on Cancellation of Debt from

Loan Modification, Short Sale, Deed in Lieu or Foreclosure

In a loan modification, short sale, foreclosure or deed in lieu of foreclosure, the owner can receive "capital gain or loss" as in any other sale of real property.  The owner will be subject to capital gains taxation on the "forgiveness of debt" or "cancellation of debt" but can also receive a credit for a capital loss (only on investment properties).

 

Taxable ordinary income is triggered by the lender’s forgiveness of debt of $600 or more.  Lender is required to issue a 1099-C but it is the individual’s responsibility to recognize a capital gain. 

 

STEP TWO:  Determine the Gain on Cancellation of Debt

Short Sale / Foreclosure (Example One)

Ordinary Income = Amount Owed - FMV

500,000 Owed to bank – 300,000 Fair Market Value = 200,000

Ordinary Income = $ 200,000

…Or…

Loan Modification (Example Two)

Forgivingness =  Amount of Debt Lender Forgave

500,000 loan – 50,000 = 450,000 adjusted loan balance

Ordinary Income = $ 50,000

Example One:

500,000 Amount Owed

300,000 FMV

200,000 Adjusted Basis

175,000 Purchase 1997

25,000 Improvements

 

Cash out-refi in 2006

Principal Residence

Owner is insolvent

Short Sale

 

II. Income from ‘Capital Gains’ on sale of property

This is only a factor if at the time of sale the Fair Market Value is greater than the Adjusted Basis in the property (your purchase price plus the cost of any major improvements).

STEP THREE:  Capital Gain or Loss =  FMV – Adjusted Basis

300,000 Fair Market Value

200,000 Adjusted Basis (175,000 purchase in 1997 + 25,000 renovation)

Capital Gain  $100,000 (300,000 FMV – 200,000 AB)

 

250/500k exclusion for gain from sale of principal residence

http://www.irs.gov/newsroom/article/0,,id=105042,00.html

If your property sold as a short sale or at trustee sale for less than you owed but more than your adjusted basis purchase price then as long as you qualify you would be exempt from taxes on the gain ($250,000 single, and $500,000 married couple).

 

STEP FOUR: Calculate Total Tax Liability

The two ways most sellers qualify for relief from cancellation of debt tax…

Most sellers are covered by one of the two methods to avoid cancellation of debt income that applies to debt forgiven in calendar years 2007 to 2012 up to 1 million for single or married filing separate and 2 million for married filing jointly:

  1. Qualifying principle residence with purchase money or refinance money used to build or substantially improve principal residence.
  2. Principle residence, second home or investment property if they qualify under insolvency rules.

       Using Example # 1 we find:

$ 200,000 Cancellation of Debt Income

$ 100,000 Capital Gain

$ 300,000 Total Ordinary Income  

          $ 0  Tax Owed:

No taxes are owed because:

No Cancellation of debt income realized because seller was insolvent at the time of sale.

IRS Form Publication 4681 “Canceled Debts, Foreclosures, Repos” http://www.irs.gov/pub/irs-pdf/p4681.pdf

“Do not include a canceled debt in income to the extent that you were insolvent immediately before the cancellation”

No Capital Gain tax due because owner qualifies for principal residence exemption of $ 250,000

 

If seller can not claim this property as a ‘principle residence’ then it may be subject to tax based on the income ‘generated’ from the ‘gain’ even though you did not actually receive any funds at the time of sale.

 

California Tax Law

 

2010 Update – California Mortgage Forgiveness Debt Relief

 

On April 12, 2010, SB 401, the Conformity Act of 2010 was enacted. It allows taxpayers who had all or part of the loan balance on their principal residence forgiven by their lender to exclude the forgiven debt from California gross income. The new law applies to discharges of qualified principal residence indebtedness on or after January 1, 2009, and before January 1, 2013.

 

http://www.ftb.ca.gov/aboutFTB/newsroom/Mortgage_Debt_Relief_Law.shtml or www.sandiegohousingsolutions.com/CADebtRelief2010.pdf

 

Tax Summary:

STEP ONE: Determine if property is a Principal Residence with Qualified PR Indebtedness?

STEP TWO:  Determine the Gain on Cancellation of Debt

STEP THREE:  Capital Gain or Loss =  FMV – Adjusted Basis

STEP FOUR: Calculate Total Tax Liability

ASK:  Does property qualify for 250/500k Capital Gain Exemption?  Are you insolvent?

 

Quick Tax Summary Chart

Tax Chart


 

 

 

 

IRS Publications, Q&A and Definitions:

 

“Mortgage Debt Relief Act of 2007”  The Mortgage Forgiveness Debt Relief Act and Debt Cancellation http://www.irs.gov/individuals/article/0,,id=179414,00.html 

The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. This provision applies to debt forgiven in calendar years 2007 through 2012 (The end date was increased by three years from 2010 to 2013 pursuant to H.R. 1424, the Emergency Economic Stabilization Act of 2008).  Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately).

 

Does the Mortgage Forgiveness Debt Relief Act apply to all forgiven or cancelled debts?
No. The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.

 

If part of the forgiven debt doesn't qualify for exclusion from income under this provision, is it possible that it may qualify for exclusion under a different provision?
Yes. The forgiven debt may qualify under the insolvency exclusion. Normally, you are not required to include forgiven debts in income to the extent that you are insolvent.  You are insolvent when your total liabilities exceed your total assets. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982. Publication 4681 discusses each of these exceptions and includes examples.

 

How do I know if I was insolvent?
You are insolvent when your total debts exceed the total fair market value of all of your assets.  Assets include everything you own, e.g., your car, house, condominium, furniture, life insurance policies, stocks, other investments, or your pension and other retirement accounts.

 

Publication 4681 - Cancelled Debt  http://www.irs.gov/pub/irs-pdf/p4681.pdf

Gives definitions and many ‘what if’ scenarios for debt cancelled from loan modification, short sale and foreclosure.

 

Form 982 - Reduction of Tax http://www.irs.gov/pub/irs-pdf/f982.pdf  

Form used in conjunction with Publication 4681. 

Loan Modification:  If you kept ownership of your home and modification of the terms of your mortgage resulted in the forgiveness of qualified principal residence indebtedness, complete lines 1e, 2, and 10b.

 

IRS Definitions:

 

Adjusted Basis - The purchase price of home plus the cost of any major improvements.

 

Fair Market Value – Generally, the gross foreclosure bid price is considered to be the FMV. If an abandonment or voluntary conveyance to the lender in lieu of foreclosure occurred, enter the appraised value of the property.

 

Investment Property -  A property you treat as an investment for income tax purposes.

 

Insolvent or Insolvency - You are insolvent when your total debts are more than the fair market value of your total assets. Assets include everything you own, e.g., your car, house, condominium, furniture, life insurance policies, stocks, other investments, or your pension and other retirement accounts.If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.

Text from page four of http://www.irs.gov/pub/irs-pdf/p4681.pdf  “Do not include a canceled debt in income to the extent that you were insolvent immediately before the cancellation”. In calculating insolvency add up all your assets, debs, the entire amount of recourse debts, and the amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt.  To report insolvency complete and attach Form 982 to your federal tax return.

 

Principal residence - Home Sale Exclusion Rules

http://www.irs.gov/newsroom/article/0,,id=105042,00.html

For taxpayers with multiple homes, the regulations list several factors relevant to determining which home is the principal residence. Among these are amount of time used; place of employment; where other family members live; the address used for tax returns, driver’s license, car and voter registration, bills and correspondence; and the location of the taxpayer’s banks, religious organizations or recreational clubs.

 

Qualified Principal Residence Indebtedness

http://www.irs.gov/publications/p4681/ch01.html#en_US_publink100080262

You can exclude canceled debt from income if it is qualified principal residence indebtedness. Qualified principal residence indebtedness is any debt incurred in acquiring, constructing, or substantially improving your principal residence and which is secured by your principal residence. Qualified principal residence indebtedness also includes any debt secured by your principal residence resulting from the refinancing of debt incurred to acquire, construct, or substantially improve your principal residence but only to the extent the amount of debt does not exceed the amount of the refinanced debt.

 

1099 A/C Form

Instructions http://www.irs.gov/pub/irs-pdf/i1099ac.pdf

Sample Blank Form http://www.irs.gov/pub/irs-pdf/f1099c.pdf 

 

 

California Non – Recourse vs. Recourse Loan   CA Civil Code 580 A-D

http://www.sandiegohousingsolutions.com/CACivilProcedure577to582.pdf

 

Non – Recourse or ‘Purchase - Money’

If a property goes to foreclosure in California, unless you refinance, the debt is non-recourse, meaning the lender cannot pursue you (unless they can prove fraud). CA Civil Code 580-B. excerpt: ”Where both a chattel mortgage and a deed of trust or mortgage have been given to secure payment of the balance of the combined purchase price of both real and personal property, no deficiency judgment shall lie at any time under any one thereof if no deficiency judgment would lie under the deed of trust or mortgage on the real property or estate for years therein”.

 

Recourse or ‘Refi - Money’

Recourse debt is when the lender is not just limited to taking the property back and the borrower may be personally liable on the debt.  Examples of recourse debt is when a borrower refinances existing mortgages, takes out home improvement loans, equity lines of credit and any debt for purchase of property that is not an owner-occupied one-to-four unit property. 

See Deficiency Judgments / Collections section for details on this.

 

Deficiency Judgments and Debt Collection

Reference the "Deficiency Judgments" section that covers how the ‘Cancellation Of Debt’ & ‘Debt Collection’ is handled by the lender.

 

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