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Relief from 'phantom income' on mortgage defaults for primary residences ...
Summary 
Click to read HR 3648
The White House - Press Release :
UPDATED: January 2008
The tax consequences arising from your situation are severe. Please contact your CPA or other tax reporting professional to clarify the foregoing and attached spreadsheet. I am not a licensed Certiified Public Accountant. You must speak with the individual who actually prepares your tax reporting forms / returns that are submitted to the IRS to determine for your particular purposes the likelihood and extent of taxation.Consider these links to explore tax impacts:
http://www.irs.gov/publications/p523/index.html
http://www.irs.gov/individuals/article/0,,id=179414,00.htmlReport on FORM 982
http://www.irs.gov/newsroom/article/0,,id=174034,00.html
Sales and Other Dispos of Assets
http://www.irs.gov/pub/irs-pdf/p544.pdfArticle: Some homeowners get relief from COD income (IRS 02.28.2008)
http://www.realestateinvestingtax.com/shortsale.shtml
http://www.toolkit.com/news/newsDetail.aspx?nid=07-004mortgage
http://www.thetaxdiva.com/2008/01/forgiven-mortgage-debt-relief-in.htmlAlso consider
Basis of Assets
http://www.irs.gov/publications/p551/ar02.html#d0e301
http://www.irs.gov/pub/irs-pdf/p551.pdf
Canceled Debts, Foreclosures etc & Solvency
http://www.irs.gov/pub/irs-pdf/p4681.pdf
Capital Gain/Loss
http://www.irs.gov/individuals/article/0,,id=138991,00.html
http://www.irs.gov/newsroom/article/0,,id=170634,00.html
http://www.irs.gov/pub/irs-pdf/i1040sd.pdf
What is the Mortgage Forgiveness Debt Relief Act of 2007 and how does it affect me?
It amends the Internal Revenue Code to exclude from gross income amounts attributable to a discharge of indebtedness incurred to acquire a principal residence. It limits to $2 million the excludable amount of such indebtedness and reduces the basis of a principal residence by the amount of discharged indebtedness excluded from gross income.
WINDOW PERIOD: The tax break applies, if at all, to debts discharged from:
January 1, 2007 to December 31, 2009INTENDED IMPACT:
Help certain borrowers avoid some of the negative consequences arising from mortgage defaults.CONGRESS PROVIDED AN 'EXPLANATION' OF THE NEW (TEMPORARY) LAW
- Principal residence is defined in this link to Section 121
- Acquisition indebtedness means any indebtedness which - (1) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and (2) is secured by such residence.
So, over-simplifying the interpretation, the MFDRA appears to apply to a homeowner's primary residence - NOT INVESTMENT PROPERTIES or SECOND HOMES - and a portion of debt - DEBT ACQUIRED TO PURCHASE THE PRIMARY RESIDENCE or MAKE CAPITAL IMPROVEMENTS - is excluded from the determation of taxation as follows:
* COD = Cancellation of Debt 1 COD* income may not be reportable for some disposing of principal residences
i. Q: did the homeowner itemize / deduct interest paid on the discharged loan?
ii. A guiding factor is reference to a homeowner's IRS Form 1040 SCH A2 COD* income relating to investment properties is still reportable / taxable 3 Negative credit consequences exist whenever there is a default 4 Calculating COD income is done by subtracting amount due on debt from qualified 'acquisition indebtedness' 5 Short sales are taxed under the same rules as foreclosures 6 There well may be different treatment of COD from purchase money versus 'cash out' and second loans such as HELOCs + LOCs 7 Homeowners who took advantage of the run up in real estate prices to do "cash-out" refinancing, in which the funds were not put back into the home but, instead, were used to pay off credit card debt, tuition, medical expenses, or other expenditures, are not covered by the new law exclusion for the cash-out amount. That indebtedness income is fully taxable income unless other exceptions such as insolvency or bankruptcy can be met. 8 Stated differently: The tax relief applies to the original purchase price, plus improvements,
of the taxpayer's principal residence. It doesn't apply to discharges of second mortgages or home equity loans, unless the loan proceeds were used to acquire, construct, or substantially improve the taxpayer's principal residence. Refinanced indebtedness qualifies to the extent it doesn't exceed the amount of indebtedness being refinanced. (Cash out from refinancing doesn't qualify for the exclusion.)
Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision. In some cases, however, other kinds of tax relief, based on insolvency, for example, may be available. See Form 982 for details.
NOTE: whether or not the MRDRA applies to a homeowner's situation, there may be capital gain or loss concerns that must be addressed by a Certified Public Accountant. Factors in determining these tax consequences include such concerns as date of purchase PLUS any adjustment to the cost basis from things like 'capital improvements'.
Note too that whether or not there is COD income, there can be a capital gains issue depending on when the property was purchased. Taxpayers must consult their CPAs to learn whether any gain must be reported or whether it might be exempt.
EXAMPLE: Thus, assume that a principal residence is secured by an indebtedness of $1 million, of which $800,000 is qualified principal residence indebtedness. If the residence is sold for $700,000 and $300,000 debt is discharged, then only $100,000 of the amount discharged may be excluded from gross income under this provision:
$ 700,000.00 FMV - Sales Price per lender approved SHORT SALE $ 1,000,000.00 Total Debt at Close of Escrow ( whether PMTD or REFI / Cash Out ) $ 800,000.00 'Acquisition Indebtedness' - Qualified Principal Indebtedness $ 200,000.00 COD INCOME derived from cancellation of debt - 1099 issued Lender may isuse 1099c unless dischargeable via homeowner declaration of bankruptcy or insolvent per IRC Section 108 NOTE: MFDRA may eliminate portion of COD Income - consult CPA Senior lienholder may not allow junior lienholder to get any payoff Junior lienholder may refuse to reconvey if not paid anything
Junior lienholder will typically release lien IF paid consideration ESTIMATED TAX BRACKET > Consult your CPA $ 50,000.00 ESTIMATED TAX ON COD INCOME NOTE: If you borrow money from a friend or relative and he or she cancels all or part of the debt, the cancellation often is treated as a gift from the lender to you. Gifts, including gifts of cancelled debts, are excludible from income. However, the cancellation of debt by a commercial lender is not a gift.
It appears that 'CASH OUT' for any purpose other than the replacement of the acquisition indebtedness or capital improvement of the property is subject to taxation.
Step # 1 - Compute Adjusted Cost Basis $ 565,000.00 Original acquisition costs / Purchase Price $ - + PLUS Capitalized buyer closing costs $ - + PLUS Capital Improvements $ - - LESS Depreciation if used as home office $ 565,000.00 ADJUSTED COST BASIS on date of sale Step # 2 - Compute Gain or Loss on Sale of Home $ 479,000.00 Amount realized on sale (sales price) $ (23,950.00) - LESS Seller Costs (i.e., commission, escrow, title, misc) $ (565,000.00) - LESS Adjusted Cost Basis (above) $ (109,950.00) EQUALS GAIN ( LOSS ) FROM SALE
Contact me to assess your particular situation.
CONTACT YOUR CPA for specific TAX QUESTIONS based on your reporting.
It is not in your best interest to wait.
Time is working against you.
Act NOW.The tax consequences arising from your situation are severe. Please contact your CPA or other tax reporting professional to clarify the foregoing and attached spreadsheet. I am not a licensed Certiified Public Accountant. You must speak with the individual who actually prepares your tax reporting forms / returns that are submitted to the IRS to determine for your particular purposes the likelihood and extent of taxation.
Paul E. Stansen, A Professional Law Corporation.
Mailing Address: 25600 Agoura Road # 545, Calabasas, California 91302
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