Foreclosure Taxation

Foreclosure TaxationSean J. NortonAttorney At LawABA Section of Taxation Public Service FellowPine Tree Legal Assistance39 Green St. Augusta, ME 04330(207) 400-3252 Direct(207) 482-9212 - Cellsjnorton@ptla.orgseanjn@hotmail.com

13 Goals / Sections1.Understand Basic Tax Consequences

2.What you should tell your client about potential tax consequences

3. Help your client prepare for tax reporting

Basic Tax Consequences: Recourse v. Non-RecourseNon-recourse loansNo Cancellation of DebtSale/disposition of PropertyWill Receive a 1099-A if Foreclosure or Property Abandonment; 1099-S if Short-sale

Recourse loansPotential cancellation of debt eventSale/disposition of PropertyWill Receive 1099-A & 1099-C if Foreclosure or Abandonment; 1099-S & 1099-C if Short-Sale

Basic Tax Consequences: Recourse v. Non-Recourse1099-A or S relate to the property disposition/sale.

1099-C relates to cancellation of debt event.

With Recourse loans, If both events take place in same calendar year.

Then Lender has option to only issue 1099-C with sections 4, 5 & 7 filled out. Ie Sale/disposition of property is recorded in the 1099-C not, 1099-A

Basic Tax Consequences: Non-Recourse LoanStraight Property DispositionAmount Realized Adjusted Cost Basis = Gain

Amount Realized = full amount of debt

Remember to add this amount into Basis too

No Cancellation of DebtLoan modification exception. See Rev Ruling 91-31 & 92-99

Basic Tax Consequences RecourseWhat is being Taxed?

Basic Tax Consequences - Recourse Bi-furcated Event

Potential for Two Taxable Events

Sale or Disposition of PropertyAR AB = Capital GainSec 121 Exclusion

Cancellation of DebtInterest and Fees not included.Mortgage Debt Relief Act (N.B. I refer to this repeatedly through the slides as the Mortgage Home Forgiveness Act)Insolvency Exception

Basic Tax Consequences - RecourseBifurcated Process

Sale + Canceled Debt (outstanding amount + interest and fees) = Amount of Debt Outstanding immediately before forgiveness + Interest & fees if cancelation event takes place sometime after foreclosure sale (might include post deficiency judgment interest).

Property Disposition = AR AB = Potential For Capital Gain

Cancellation of Indebtedness Income = Ordinary Income Rates

Basic Tax Consequences - RecourseStart with Property Disposition

What is the Amount Realized IRS Pub 4681

Lesser of: FMV orAmount of Loan Outstanding Immediately Before Disposition deficiency judgment.

In this lecture: Assume FMV is less. Normal in Todays economy.

Recourse Property DispositionAmount Realized (AR) = FMV of PropertyShort SaleAR = Sale Price

Deed In LieuAR= Appraised Value

ForeclosureAR = Gross Foreclosure Bid Price.

AbandonmentAR = Appraised Value.

10Basic Tax Consequences Recourse Step 2Cancellation of Debt

Why is This Income?

Obligation to Repay is Extinguished

Hard to Explain to Clients

Basic Tax Consequences - RecourseHow to Calculate Cancellation of Indebtedness Income in Foreclosure Setting:

CoD Income:

Amount of Indebtedness:200,000FMV of Property at Foreclosure100,000

Amount of Canceled Debt to 100,000report on 1099-C

Basic Tax Consequences - CoDExceptions

Gifts

Certain Student Loan Forgiveness Programs

Otherwise Deductible Debt

Basic Tax Consequences - CoDExclusions:

Bankruptcy

Insolvency

Qualified principal residence indebtedness added by Mortgage Forgiveness Debt Relief Act of 2007 (MFDRA) for debt cancelled before January 1, 2013.

Form 982

What do you Tell your ClientAnticipate a 1099-A/S and 1099-C.

If you ignore, likely to have IRS assessmentAutomated Substitute for Return

You will need to speak to a tax prof. about thisRecommend a CPA or Tax Attorney or Enrolled Agent.Who understands these issues

Suggest finding an AARP Tax Prep Volunteer Who is certified to handle CoD income 1-888-687-22771-877-434-7598 (TTY)

Ive created this file to assist your tax planner. Retain this file and give to him or her.

What do you Tell your ClientLoan Modification

Disclose potential for cancellation of debt Before moving forward with transaction?At time Mod is executed?At closure of case?

HAMP and Revenue Procedures

Rev Proc 2013-16Principal reduction alternative

Rev Proc 2009-23HAMP and General Welfare Exclusion

What do you Tell your ClientLoan Mods, Interest and Capitalization.

Rule 1:

Interest that is capitalized into principal by the SAME lender (whether or not denoted a modification) remains interest, and should be amortized over the remaining (or new) term of the loan. It has not become principal for tax purposes. See Davison, 107 TC 35 (1996).

What do you Tell your ClientLoan Mods, Interest and Capitalization.

Rule 2.

Interest that is capitalized into principal by a DIFFERENT lender at the time of a refinancing is deemed to have been paid at the time of the refinancing and is deductible at that time. See Menz, 80 TC 1174 (1983).

What do you Tell your ClientLoan Mods, Interest and Capitalization.

Thus, It is actually necessary to ascertain the identity of the new lender. With FNMA-type loans, that may have been packaged and repackaged, it is possible that an apparent modification is actually a refinancing. If that is the case, then the interest may become currently deductible. See Franklin v. Commr, 683 F.2d 125 (5th Cir. 1982).

What do you Tell your ClientLoan Mods, Interest and Capitalization.

Final Rule

Once the interest has been deducted (or should have been deducted), then its cancellation would be COD.

Help Your Client Prepare for Tax Reporting

Help Your Client Prepare for Tax Reporting For all transactions:

Include Original Loan Document.

Highlight Any Post Deficiency Judgment Interest Rates

Foreclosure TaxationSean J. NortonAttorney At LawABA Section of Taxation Public Service FellowPine Tree Legal Assistance39 Green St. Augusta, ME 04330(207) 400-3252 Direct(207) 482-9212 - Cellsjnorton@ptla.orgseanjn@hotmail.com

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