Discussion:1098 and Short Sale on Primary Residence

He received a 1099-C for approximately $150K. Based on the Homeowner Protection Act, this should be non-taxable, but reported on Form 982.

He also received a 1098 from the bank for $36K in mortgage interest and $15K for property taxes paid. The catch is that he did not pay all of the mortgage interest or the property tax (a good portion was paid through the short sale escrow).

Can he still deduct the full amount of the 1098 mortgage interest and property taxes even though he physically did not pay them from his own funds?

Theoretically, he "paid" these through the sale proceeds - he was liable for them. My thought would be they would be fully deductible, but I can't find any authoritative guidance to tell me otherwise.

Anyone else has a similar circumstance?

In 2004 he refinanced the 1st, but not the 2nd. He then owed 290k on the first. He put 3k of this into his home. He paid a prepayment penalty, and points worth about 7k. I still can't figure out where this comes into play. And why the prepay and points don't matter with the 2nd refi. But in a class was told to get these figures.

He refinanced again in 2005, both the 1st and 2nd, and owed 319,200.

He stopped making payments last year and the balance is currently at 375k. If I figure this correctly, his acquisition debt is the 253k he owed at the time of the 1st refinance, plus 3k he put back into his home. The bank has agreed to a short sale price of 180k. But the 2nd is requiring that the client pay 9500.00 at closing or sign a promissory note with 0% interest. So I figure 375k-180k-9500=185,500 COD income But what about the extra money he pulled out during the refi that wasn't acquisition debt? The total of that would be 35k I did check for insolvency and they have assets of approx. 70k I realize these are ball park figures and will change some before the sale is final. I am getting calls similar to this every day now. All the IRS examples, show one or the other, but not how to break up the COD to allocate it to the exclusion vs the insolvency We live in CA. Any help would sure be appreciated. I have spent several hours researching this, the harder I try to figure it out, the more confused I become. Thanks so much!!!!

Sounds like the mortgage grew from $319,200 to $375,000 as a result of accrued interest. Thus, for purposes of computing COD, we would use the first figure, not the second figure.

Home acq debt is approximately $205,000 or less. Home equity debt is approximately $114,200. Total COD income is apparently 129,700, of which $15,500 is eligible for exclusion under IRC 108(a)(1)(E).

It appears to me that the taxpayer would be better off not using 108(a)(1)(E) since the amount of his insolvency appears to be more than $15,500.

Home acq debt I thought was 256,000. Based on the fact that he owed 253,000 when he first financed and then put 3000 additional into his home. I added those two. I figured the insolvency as being less. I took the 180,000 FMV of home and added 70,000 of assets, then subtracted the 375,000 now due. I came up with 125,000 insolvent. Since the COD is going to be 185,500? ( the balance of 375,000 - FMV of 180,000 - the 9500 they will still owe) If the Acq debt is 256,000, this leaves 109,500 not excludable. That would give me 76,000 eligible for the exclusion. They wouldn't be able to wipe it all out with the insolvency. I finally found in Pub 4681 where we can in fact use both. I appreciate your time in helping me with this. Please let me know where my thinking is off here. Thanks

Home acq debt I thought was 256,000. Based on the fact that he owed 253,000 when he first financed and then put 3000 additional into his home. If he meets the 30-day rule, then yes.

The reason that the insolvency exclusion will work out better is that under IRC 108(a)(1)(E), non-acquisition debt is cancelled first. Remember that only home acq debt qualifies for the 108(a)(1)(E) exclusion.

But the third one. If the insolvency is not enough to cover the entire 1099, then wouldn't I need to then exclude the remaining acquisition debt using the 108(a)(1)(E) exclusion? You have been a great help and thanks in advance.

(C) FTC Principal residence exclusion takes precedence over insolvency exclusion unless elected otherwise. Paragraph (1)(B) shall not apply to a discharge to which paragraph (1)(E) applies unless the taxpayer elects to apply paragraph (1)(B) in lieu of paragraph (1)(E).

Quoting directly from the House Committee Report:

Under the bill, the exclusion does not apply to a taxpayer in a Title 11 case; instead the present-law exclusion applies. In the case of an insolvent taxpayer not in a Title 11 case, the exclusion under the bill applies unless the taxpayer elects to have the present-law exclusion apply instead.

However, the example in Pub 4681 treats the discharge of the mortgage debt as 2 separate discharges -- a discharge of principal residence acquisition debt and a separate discharge for the mortgage debt that is not principal residence acquisition debt.

Since the Pub 4681 example yields a better result than the actual statutory language, I would be inclined to accept the example in Pub 4681.

See IRC Sec. 108(a)(2)(C) says that a discharge TO WHICH the principal residence exclusion APPLIES is not eligible for the insolvency exclusion. The equity debt is not qualified debt and can't apply. Therefore, this pertains to acquisition debt only. That is why the example works :)