Discussion:Short Sale of Former Primary Residence
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Discussion Forum Index --> Tax Questions --> Short Sale of Former Primary Residence
| 4 May 2008 | |
| My clients purchased a new home 18 months ago. They have been trying to sell their former residence to no avail. It has never been a rental. They are now facing a short sale of this former residence. Short selling this residence will result in a gain of $50k. Because this home was their primary residence for two out of the last five years they will be able to exclude this gain against their $500k exemption. Short selling is also going to result in a “recourse” debt forgiveness of 85K. Can this debt forgiveness be absorbed with the remainder of their $500k exemption or will they have to count the 85K as ordinary income regardless? Thanks in advance. | |
| 4 May 2008 | |
| What do you mean by short sale? -- Larry Hess, CPA | Albuquerque, NM | Talk to me | |
| 4 May 2008 | |
| I'm not familiar with the short sale of real estate. How does it work? | |
| 4 May 2008 | |
| There have been lots of discussions here about this - not sure if a link to search results will work, but start here and then refine or expand the list, as there are plenty of qualifying questions and pointers amongst the many posts: | |
| 4 May 2008 | |
| A short sale is an alternative to foreclosure that lenders sometimes offer for some properties. The lender accepts less than the amount owed on the property hence the forgiveness of debt.
Ed, I would think the forgiveness of debt of 85K would qualify for the exclusion of income based on the Morgage Forgiveness Debt Relief Act of 2007. Good article on IRS site: http://www.irs.gov/newsroom/article/0,,id=174034,00.html As Trillium says try a search on this site and you should find quite a bit more info. | |
| 5 May 2008 | |
| Report the COD on Form 982. A short sale or a deed in lieu of foreclosure is no different than a regular foreclosure for tax purposes. The sales price is the lesser of the FMV or mortgage relief for gain or loss. | |
| 5 May 2008 | |
| Don't think the $85,000 will qualify for the Mortgage Forgiveness Relief Act exclusion since it does not appear to be home acquisition indebtedness. | |
TheTinCook (talk|edits) said: | 5 May 2008 |
| It still qualifies for the §121 exclusion. | |
| 5 May 2008 | |
| Riley, what am I missing? Why do you say it doesn't appear to be home acquisition indebtedness?
TinCook, what are you saying qualifies for the 121 exclusion the 50K, the 85K or both? This is an area I'm very interested in understanding better as I have a client who will be facing a very similar situation in 2008. | |
| 5 May 2008 | |
| By inference, the original post indicates that the current principal balance exceeds the original purchase price by $135,000. The original post also indicates that the principal balance exceeds the fair market value of the property by $85,000. Thus, the Sec. 121 gain will be $50,000 (presumably all excludable).
The statute requires the $85,000 in COD income to be allocated first to home equity indebtedness, which does not qualify for the Sec. 108(a)(1)(E) exclusion. The moral of the story is that the Sec. 108(a)(1)(E) exclusion really doesn't help someone who has refinanced their home for far more than the original purchase price. | |
| 5 May 2008 | |
| I just noticed that the original post is from an Arizona practitioner. If the property in question is located in Arizona and is on a lot that is 2 ½ acres or less, Arizona anti-deficiency laws may apply, in which case the debt would be nonrecourse and the principal balance on the mortgage would be treated as the sales price of the property.
Since I do not live in Arizona, I suggest you consult an Arizona real estate attorney to confirm that the debt in question is nonrecourse under Arizona law. | |
| 5 May 2008 | |
| I believe another possibility exists where the $85K COD could be waived and that is the insolvency concept.If on the date of discharge the taxpayer was insolvent by at least $85 K, note I did not say bankrupt, then the COD could be waived. Taxpayer would need to develop a personal balance sheet as of the date of discharge to detewrmine if he/she qualifies.
This is exclusion number 1b on IRS form 982. As I understand it the balance sheet should be attached to form 982 when filed. | |
| 6 May 2008 | |
| If the Arizona anti-deficiency laws apply, there would be no COD income. | |
| 6 May 2008 | |
| Thanks Riley, your explanation helped. We're going to be seeing a lot of these in AZ in the coming year. | |
| 9 May 2008 | |
| Someone asked me today if the new Mortgage Foregiveness rules apply to a former principal residence. I see nothing in the statute to say one way or the other. However, reading the committee reports, I get a sense that Congress did not intend the new exclusion to apply to individuals who were able to purchase a new principal residence before losing their former principal residence through foreclosure. Any thoughts? | |
| 10 May 2008 | |
| Presumably the former home is now the second home or a rental. Throughout the language in HR bill 3648 there s an emphasis on the home must be your qualified principal residence. Obviously you can only have one principal residence at any one given point in time. Also the language specificlly excludes second or vacation homes. The IRS web site has a good Q&A on the subject. | |
| 10 May 2008 | |
| I think it is question of reasonableness. I think it is reasonable to expect the taxpayer to move out of the home several weeks before or several weeks after the foreclosure sale. However, I wouldn't think that a taxpayer should really expect relief if he hasn't lived in the home for an extended length of time prior to the foreclosure sale. | |
| 10 May 2008 | |
| That seems reasonable to me particularly if the taxpayer moves to a rental. However it's hard for me to foresee a situation where a taxpayer would have a short sale on his personal residence and then subsequently purchase another principal residence. The reason for the short sale is he's upside down and can't afford the payments . | |
