As home owners throughout our nation have struggled to either retain their properties or minimize the damage in losing them, they have looked towards a patchwork of government programs for help.  These programs such as Hope for Homeowners, HAMP, and now HAFA have promised a lot but delivered very little results so far.  The one effective relief program has been the Federal Debt Foregiveness Relief Act and comparable State laws which enables homeowners to avoid taxes on the forgiven debt on their principal residence.  No such program has been created to protect investors but… relief from these taxes may be available anyway.

Debt Forgiveness Tax arises anytime a lender is not paid in full on a loan. Typically, this is measured by the lender issuing an IRS 1099 for miscellaneous income showing what was owed and what was paid. You get taxed on the difference as income unless some exemption applies. There are several.

1.  Capital Loss Offset - When you buy a property, your purchase price generally establishes your “taxable basis”, ie: what you invested. This is increased by capital improvements you make, such as a new roof, and it is decreased by your depreciation write off.  For many investors, your taxable basis may be much higher than the current market value and higher still than the amount owed on the property. For example, if you purchased for $500,000 with a $400,000 loan and the property sells or is foreclosed at a price of $250,000 (not uncommon); then you would have a debt forgiveness of $150,000 (amount of loan unpaid in the sale) but you would also have a capital loss of $250,000 (amount invested less sale price).  Accountants are generally in agreement that you can offset the debt forgiveness tax with the capital loss. In this example, the result would be elimination of the debt forgiveness tax and a carry-over remaining capital loss of $100,000 which could be applied against other investment losses. 

2.    IRS Insolvency Exclusion - In my February 19th posting, I wrote about how the Insolvency Exclusion works as detailed in IRS Publication 4681 “Cancelled Debts, Foreclosures, Repossessions, and Abandonments”. http://www.irs.gov/pub/irs-pdf/p4681.pdf.  The important point is that this Exclusion applies equally to homeowners as well as investors.  In short, you list all of your liabilities and below that list all of your assets. If your liabilities are greater than your assets, you are “Insolvent” for debt forgiveness purposes and can avoid the debt forgiveness tax. Many States, including California, have adopted the IRS Exclusion to apply to State debt forgiveness taxes as well.

3.  Bankruptcy - although this is a last resort for owners and investors alike, if a property is lost during the pendency of the Bankruptcy there will be no debt forgiveness tax applied. You cannot use BK to avoid taxes already incurred before the Bankruptcy is filed.

Before you make any decision concerning your upside-down home or investment property, be certain to get tax and legal advice from qualified professionals in your area who can look at your specific situation and advise you on how these rules apply to you.  This Article is solely intended to give you an introduction to what might be available for you but you should not rely on it to apply to your financial circumstances.

If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.

 has been the investor market

As many already know, the California legislature passed SB 401 on April 9th. While Gov. Schwarzenegger originally said he would not sign the Bill due to tax riders, but he signed the Bill yesterday  and it is now law.  California law will now be aligned with the Federal Mortgage Debt Forgiveness Relief Act and will give CA owner-occupant property owners debt forgiveness tax protection through 2012 and retroactively running from 2009 (2007-2008 already protected). To learn more, read today’s article by Jim Wasserman in the Sacramento Bee: http://www.sacbee.com/2010/04/13/2674065/california-wont-tax-forgiven-home.html.

There is some confusion in the Blogging world concerning debt forgiveness relief.  Some believe that the forgiveness automatically exists if the loan or loans were acquisition loans (1 to 4 unit, owner-occupied). This would be correct if the owner never refinanced and stayed owner occupant throughout. But it would not be correct if the owner later moves and rents the propertyout.  If you are in this situation, be sure to check with your accountant to determine how this will apply yo your situation.

If you have any questions concerning your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at sjbeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.

Over the past year, I have posted numerous Articles which in part deal with Debt Forgiveness and the receipt of a 1099 form from a lender.  Now, as we’re seeing lawsuits being filed by some lenders to collect on unpaid debt after foreclosure, borrowers are saying “Wait… they gave me a 1099! Doesn’t that mean the debt is forgiven?” The answer is maybe.

A 1099 is simply a type of IRS form used to report income other than wages, salaries, and tips. The most common forms are:  1099-Misc to report miscellaneous income; 1099-Div to report dividend income; and the 1099-Int to report interest income.  Following foreclosure two different forms of 1099 are used: the 1099-C to report cancelled debt; and the 1099-A to report the acquisition or abandonment of a secured property. It is this last one that causes the confusion and no doubt will be the subject of litigation.

The 1099-A contains several boxes, one of which requires the lender to state whether the borrower was personally liable for the debt or not.  If there is no liability (such as in California with acquisition debt or following the lender’s Trustee Sale), then the unpaid debt amount is forgiven and debt forgiveness tax can be assessed (unless an exclusion applies). This gives the same result as the 1099-C. But… where the 1099-A states that the borrower is personally liable, then the filing of the 1099-A  might not mean debt is forgiven. Rather, it may mean that the lender has only filed the form to designate that an event has occurred and they have not as yet determined whether or not to cancel, ie: forgive, the debt. This is a very confusing result. 

You can learn more about the use of 1099-C and 1099-A on IRS Publication 4681: http://www.irs.gov/pub/irs-pdf/p4681.pdf. For any of you Accountants reading this, if you can shed more light on this, please post a Reply or e-mail me at sjbeede@bpelaw.com.

Watch this Blog for further insight as this issue gains greater clarity. We’re just starting to provide defenses for borrowers sued by wiped out junior lenders and the role of the 1099 may be an important defense argument (as well as the many other defenses that may exist).  Remember, lenders want to try to get paid but they don’t want to throw good money after bad. If there is some recourse, a settlement may be the fastest and most cost-effective result for everyone.

If you’re facing a post-foreclosure lawsuit or have any questions concerning upside-down loans or your rights and obligations concerning real property, foreclosure, or any related issues, please feel free to contact me at stevebeede@bpelaw.com or contact my office at 916 966-2260 for a confidential appointment by phone or in person.