As my readers are aware, we’ve been grappling for many months over whether “Personal Residence” means 1) where you live at the time the property is sold or foreclosed; or 2) where you lived for 2 of the past 5 years. Obviously we’d all like the 2nd definition to apply since that would give debt forgiveness tax relief to the many property owners who have rented out their homes or moved.
I have argued that the 1st definition controls based upon the following statements in the IRS Publication 4681 concerning Cancellation of Debt. In that document, the IRS defines Qualified Personal Residence Indebtedness as: “any mortgage you took out to buy, build, or substantially improve your main home. It also must be secured by your main home. Qualified principal residence indebtedness also includes any debt secured by your main home that you used to refinance a mortgage you took out to buy, build, or substantially improve your main home, but only up to the amount of the old mortgage principal just before the refinancing.” The IRS then goes on to define “Main Home” as: “the home where you ordinarily live most of the time. You can have only one main home at any one time.” Given this definition, I do not see how one could identify their Main Home as being anything other than where they live now. This supports the argument that you must live there to get the debt forgiveness tax relief. But, that may not be as clear as it sounds.
In a 2007 Publication on the tax impacts of foreclosure, the California Franchise Tax Board defines the taxpayer’s principal residence as “where they have lived for at least two of the past five years”. However, at that point, the FTB was talking about the possible capital gains liability from a foreclosure and for that purpose, the 2 of 5 year Rule does apply.
All of the commentarors on this issue look to U.S. Code Section 121 - Exclusion of Gain from Sale of Principal Residence – which provides: “Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more”. So, does this only concern Capital Gains Tax or does it include Debt Forgiveness Tax?
We get some clarity from the language of the actual law: “The Mortgage Forgiveness Debt Relief Act of 2007″ which states at Section 2.5: “principal residence’ has the same meaning as when used in section 121″. ie: the capital gains definition does apply. This was reaffirmed in 2008 when Congress passed the “Emergency Economic Stabilization Act of 2008″ which created the TARP bailout program for banks and extended the operative term of the Debt Relief Act to December 31, 2012. The joint committee report for the EESA states that the meaning of personal residence for purposes of the QPRI exclusion is the same as in Section 121.
So, what should we conclude from all this? It does appear that the intent of Congress in passing these laws is that a foreclosure is considered to be a “sale” and the definition of “Principal Residence” shall be the 2 of 5 year Rule set forth in U.S. Code Sec. 121, not the Main Home definition that the IRS appears to be using. It also means that there may remain an ambiguity in the law that has yet to be defined conclusively. Arguably, the IRS could disallow an exclusion from Debt Forgiveness Tax when the debtor was not living in the home at the time of sale. Will they do so? We don’t know yet. What we do know is that if you need the 2 of 5 year definition to apply to you, be sure to get competent advice from an accountant or CPA that you trust and who knows these issues.
If you have specific questions about your liability, short sales, foreclosure, or any legal issues, feel free to contact me at firstname.lastname@example.org. We offer a $200 flat fee consultation to evaluate your liabilities and strategize a resolution. This can be done in person or by phone. If interested, please call us at 916-966-2260. Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: /http://www.stevebeede.com/copingwithanupsidedownmortgage