Submitted by Chris Moss CPA
Only the IRS could tax you after you have lost your home in foreclosure. But that is exactly what used to happen if your lender sold your home at a sheriff’s sale for less than your mortgage and did not come after you for the difference. What a surprise when you would receive form 1099 from your lender the following year and your CPA would have no choice but to report that amount as “other income” on line 21 of your form 1040 annual income tax return.
That all changed when Congress enacted the Mortgage Forgiveness Debt Relief Act in 2007 just as the Great Recession was starting. Millions of Americans benefited. Primary, business and rental property were all included in one way or another. Eventually all but primary home mortgages expired and finally primary mortgage provisions expired December 31, 2013. So unless Congress renews the expired provision debt forgiven in 2014 will be taxable.
What is Congress doing? The Senate Finance Committee approved the extender provision but Senate Majority leader Harry Reid (D-Nev) stopped the action on the Senate Floor. House Ways and Means Dave Camp (R-Mich) is not holding hearings at all on extending. My prediction is that Congress is waiting until after the November 2014 elections and will then extend the law in some fashion. But what if they do not?
If you have a pending short sale here are a few sets of facts which might apply to you:
For those taxpayers who have abandoned their home and are living somewhere else: If the opportunity for short sale comes up before foreclosure take advantage of the short sale making sure the lender forgives you the debt. But without jeopardizing the short sale delay the deal so that the short sale closing is perhaps January 2015. Worst case if Congress does not act is that you pay the tax in 2016. Remember, it is always better to delay than to pay.
However, there are many taxpayers who need to sell their home in order to relocate for a better job or to be closer to family somewhere else in the country. If these facts apply to you and you are still living in the upside down house then perhaps a different tax strategy would work for you. Do you have a rental property with equity that you can sell at a loss? If you must short sale your primary in order to move you have options. First you can coordinate the sale of both properties so that the gain on the short sale offsets the loss on the rental. Make sure you consult your CPA on this one.
Second, if you were to convert your primary to a rental (see my last month’s blog) and your rent was able to carry the home, you could move and rent in your new location until you eventually could sell your primary. After you sell the former primary you could then purchase in your new location. You may be able to have enough losses on the short sale rental to offset the debt forgiveness. As mentioned in my previous blog, there is no requirement that the house actually has to be rented as long as there was a genuine attempt to do so with plenty of advertising and signs outside the house. Just so you know your losses are limited to the time the house was rented so make sure to consult your CPA on this strategy as well.
Third for those folks who actually have a gain with a short sale this is a very interesting set of facts and carries with it a custom tax strategy just for you. Let’s say you were gifted your primary house years ago with a very low basis and no mortgage. However you put an equity line on the house of 70% of the value (remember those days?). You used that money to invest in a franchise business and the business is doing very well but all your money is tied up on the business and you don’t want to sell. Just like everyone else you lost that 30% equity over the last ten years. You moved out of the now underwater house at some point and rented it out as millions of other taxpayers have done. You are now upside down on the house and do not have the money to cover a short sale difference. Let’s say 200k. But you have a great new business opportunity and want the hone equity line paid off. If you shortsale, not only will your $200K be taxable but you will have a large capital gain on the sale. It is imperative for these taxpayers to prove that they have lived in the house for 2 of the last 5 years to take advantage of the $250,000 exemption ($500,000 if married). If you only lived in the house less than 2 years out of 5 there is still hope if the facts show that your driver’s license voter registration and tags were all still registered at that address and that you did not immediately rent the house out. See US Tax Court Case Richardson V Commissioner This set of facts is very complex and it is essential to consult with you CPA sooner than later.
In conclusion there are many Americans who will still be short selling in 2014/2015. Whatever your circumstances go over with your CPA the facts in your case. Document those facts on the tax returns you file and make sure the IRS knows what you are doing. If Congress extends the Debt Relief Act then all is good. But what if Congress does not extend the Debt Relief Act? Wish there was an easier way? Let you elected Representatives know you want the Debt Relief Act extended…at least long enough to allow you to short sale your house.
Thanks for visiting us at TaxView with Chris Moss CPA. See you next time on TaxView.
Chris Moss CPA