Discussion:IRS Chief Counsel, "California Short Sale = Nonrecourse"

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Discussion Forum Index --> Tax Questions --> IRS Chief Counsel, "California Short Sale = Nonrecourse"

Wiles (talk|edits) said:

3 December 2013
http://online.wsj.com/public/resources/documents/IRSResponse.nonrecourse.pdf

Ckenefick (talk|edits) said:

3 December 2013
Maybe it's a technicality, but Dave Fogel's article references 580(d) whereas the above link references 580(e). What's the difference?

Terry Oraha (talk|edits) said:

3 December 2013
California Tax Lawyer

By David M. Fogel, CPA Does a Non-Judicial Foreclosure Convert Debt from Recourse to Non-Recourse? [1]

Ckenefick (talk|edits) said:

3 December 2013
Right, that's the article I was referring to. Is the distinction that one provision concerns deficiencies relating to foreclosures and the other provision concerns deficiencies relating to lender-approved short sales?

At the end of the day, don't we pretty much have the same thing in both cases: Lender is precluded from seeking a deficiency judgement? If so, would we not expect the federal tax result to be the same? I'm just asking the question.

I can see how we might have a difference if, from the minute the loan was issued, the lender is precluded from seeking a deficiency judgment in one instance. Here, it would indeed make sense that the loan is treated non-recourse. Whereas in a situation where the debt was recourse from the get-go, but the lender's later decision to go the non-judicial foreclosure route precludes a deficiency judgment, it would make sense that this debt would retain its character as recourse (as Dave Fogel opines).

But I do wonder: In the situation where the debt was non-recourse initially, couldn't the lender pursue a deficiency judgment if the property no longer qualified as a residence (i.e. it was converted to a rental)?

Wiles (talk|edits) said:

3 December 2013
What's the difference?

Whereas in a situation where the debt was recourse from the get-go, but the lender's later decision to go the non-judicial foreclosure route precludes a deficiency judgment, it would make sense that this debt would retain its character as recourse (as Dave Fogel opines).

Great point. I am not sure the difference either. It seems if the IRS opines that the short sale agreement converts a loan from recourse to nonrecourse, then the same should hold true when the lender chooses a non-judicial foreclosure.

Looks like I have some amended tax returns to prepare...The strange thing is that I subscribe to 2 tax update services that send me daily e-mails. Why did I not find out about this 9/19/13 opinion until today?

RexT2013 (talk|edits) said:

3 December 2013
Dave Fogel has informed us taxpros in N. Calif. that the IRS misinterpreted 580e in the letter to Boxer. He says that all this section does is to cancel the debt remaining after the short sale, it doesn't convert a recourse debt to nonrecourse. He says that he has sent a letter to the author of the letter asking Chief Counsel to reconsider its decision.

Converting the property to rental use doesn’t change the nonrecourse debt to recourse because the character of the debt as a purchase-money loan covered by 580b is determined by the facts and circumstances which existed at the time it was created. See Costanzo v. Ganguly, 12 Cal.App.4th 1085 (1993).

Wiles (talk|edits) said:

3 December 2013
I agree that they are likely mistaken, but why do we want to point this out to them? :)

Rex, would you be so kind as to share what service/membership you are referring to when you say "Dave Fogel has informed us taxpros in N. Calif..." I think I may want to join

EZTAX (talk|edits) said:

3 December 2013
Just when I thought I was getting on top of this!

Ckenefick (talk|edits) said:

3 December 2013
Rex's comments are informative. And, I'd like Dave's response as well.

Again, I can kinda see arguments both ways depending on the situation we're dealing with.

If there is no way possible for a debtor to be on the hook for a deficiency, from the get go, then that is the nature of a non-recourse debt. Here, I would be talking about some debt that satisfies some CA Code Section when the debt was issued. That is, I'm not talking about a recourse debt that, due to a later non-judicial foreclosure, prevents a deficiency judgment. As such, if we have a debt that is initially recourse, but the lender makes a future decision that involves the lender not being able to sue on a deficiency (i.e. a non-judicial foreclosure), I can see that debt as being recourse all along, from beginning to end.

So, I can kinda see why we might have 2 different results here, depending on the facts. And I do wonder if part (or all) of the difference lies in 580(d) vs. 580(e).

Terry Oraha (talk|edits) said:

3 December 2013
The determination of recourse / nonrecourse is not something that's determined by the IRC, it's a matter of state law. The letter to Barbara Boxer really didn't provide any analysis for its conclusion, after all it was just a letter. I've never heard that a letter to a Senator should be considered a type of guidance promulgated by the IRS, so I would hold off on amending any returns. When someone has it all figured out I would assume they are going to do a comprehensive analysis of the relevant state law interpretations in drawing a conclusion. I noticed Dave had cited some authorities for his conclusions. I was more concerned that many California Attorneys had other opinions. I wonder what their reasoning was; I think they are more concerning than the Boxer letter. Also, the Boxer Letter said the obligations should be considered non-recourse for purposes of 108, but not other income tax purposes. What's up with that?

Tkelly911 (talk|edits) said:

4 December 2013
The letter from Chief Counsel is from DC. It will command a lot of respect. And to change the position taken would be to throw egg on the face of "Call me Senator!" Boxer, whose office put quite the PR spin on this, "saving" homeowners from the evils of cancelled debt. And since the realtors of California blocked conformity to the Mortgage Forgiveness Act extension this year, this serves to save many a taxpayer.

That said, the letter is a very superficial approach. Contrast this to Dave Fogel's usual meticulous, well annotated analysis and one can see where if there a challenge to this position it would be very vulnerable.

Ckenefick (talk|edits) said:

4 December 2013
Great points. Is this the deal: 580(d), which is what Dave wrote about, deals with non-judicial foreclosures. 580(e), on the other hand, deals with lender-approved short sales.

Do I have that right?

If I do, then these things are basically the same. They involve a recourse debt that turns into something else upon the occurrence of a future event. Neither is "non-recourse" from the get go. As a result, we should end up with the same tax treatment.

I too vote for Dave Fogel on this one.

If we were to take the IRS' approach, I think we go down a very dangerous path for one primary reason: It seems we could easily convert a recourse debt to a non-recourse one. Let's say a taxpayer has a recourse debt and pays the lender $10k to release his personal guarantee. Do we now have a non-recourse debt? According to the CCA, we very well might. Under state law, the bare naked debt that now lacks a personal guarantee is no different than a "recourse" debt for which the lender cannot sue on a deficiency.

When it comes to modifications of debt instruments, this issue is addressed in -3 of 1001.

And to Terry's point, I've also linked this before:

http://macpamedia.org/media/downloads/2011ATI/day5/Recourse_Nonrec_all.pdf

...just goes to show how complicated this nonrecourse v. recourse issue can really be. If you really, really think hard about it, the notion that recourse means, "Someone is personally responsible for repayment" sounds real nice, but can get real dicey. Where is the line between recourse and nonrecourse anyway? What if all my assets are pledged as collateral - Is it recourse or nonrecourse?

Dennis (talk|edits) said:

4 December 2013
Seems to have application to single action states. Something I always wondered about. Bank has a choice to treat the obligation either way.

Wiles (talk|edits) said:

4 December 2013
"And since the realtors of California blocked conformity to the Mortgage Forgiveness Act extension this year, this serves to save many a taxpayer."

Tim, is this true? If so, combine that action with this letter giving preferential treatment to a short sale transaction, which requires the services of a realtor, then something is smelling fishy...

WEISSEA (talk|edits) said:

4 December 2013
CA does not conform in 2013 to the Federal COD Principal Residence exclusion( IRC §108(a)(1)(E) and IRC §108(h)). CA expects 80-90,000 2013 short sales. Lots of people in hardship situations.

CA Senator writes letter to IRS Commissioner to clarify COD under CA short sale anti-deficiency laws. IRS opines, under the anti-deficiency provision of CA Code of Civ. Proc. §580e, the debt would be a nonrecourse obligation, and for federal income tax purposes the homeowner will not have COD income. Instead, the full amount of the nonrecourse indebtedness is treated as the sales price. IRS states it does not opine on whether the debt is non recourse for other federal tax purposes or does it opine on other States with anti deficiency statutes. Because California conforms to IRC §108, with certain unrelated exceptions, California will conform to the IRS letter. (CA R&TC §17024.5). Lots of CA short sellers will now get relief due to the Senators action. Never argue with the gift horse.

Tkelly911 (talk|edits) said:

4 December 2013
The California Association of Realtors (CAR)were big supporters of the conformity to the federal COD relief extension in California SB30. But then, always looking for more tax revenue, the state Senate attached a bill requiring a $75 recording fee (SB 391) to SB30. This resulted in opposition by CAR to the very bill they had originally sponsored. As a result, the bill to conform failed to pass out of committee because only the Republicans voted for it.

Wiles (talk|edits) said:

4 December 2013
Whoa!! You said "Republicans" as in plural. I didn't realize there were any Republicans left in the entire state. I thought they had all moved to Texas by now.

From the opinion letter (emphasis added): In 2011, California enacted an anti-deficiency provision under section 580e of the CCP, which generally prohibits a lender who holds a deed of trust on a homeowner's principal residence from either claiming a deficiency or obtaining a deficiency judgment from the homeowner after agreeing to a short sale. The statute effectively limits the homeowner's liability to the amount the lender received on the sale of the principal residence, and the homeowner is not personally liable for the deficiency balance...if a property owner cannot be held personally liable for the difference between the loan balance and the sales price, we would consider the obligation a nonrecourse obligation...We believe that a homeowner's obligation under the anti-deficiency provision of section 580e of the CCP would be a nonrecourse obligation...

That is the extent of the Chief Counsel's analysis. I do not see any difference in the anti-deficiency language between section 580e and 580d.

Ckenefick (talk|edits) said:

4 December 2013
That's my take too. When I first read the CCA (quickly), I thought 580(e) maybe involve a situation where the lender was, from the get go, never permitted to seek a deficiency judgment. Upon further reading, it seems that the non-recourse-i-ness only develops in the future (never from the get go), once a lender decides to go the non-judicial foreclosure route or approves a short sale.

But also consider a situation where events are far apart. Say you have a recourse debt, but sufficient equity is built-up in the property, so the lender agrees to release the borrower from his personal guarantee in Year10. Then, in Year15, things go south and we have a foreclosure or a short sale. Does it not seem that in this scenario the debt should be treated as non-recourse in Year15, upon the taxable event (forgetting about the -3 Reg for a moment)?

Dennis (talk|edits) said:

4 December 2013
In single action states we have tended toward the opinion that the act of foreclosure defines the obligation as non-recourse. Until the lender decides on course of action recourse/non-recourse would have no meaning. This seems confirmation.

Ckenefick (talk|edits) said:

4 December 2013
I can definitely understand that position.

Until the lender decides on course of action recourse/non-recourse would have no meaning.

This is probably why the CCA narrows it's conclusion to 580(e), because recourse/non-recourse is important for other purposes prior to the lender's decision (i.e. allocating liabilities under Sec 752).

The issue with a foreclosure/short sale, with respect to the specific CA anti-deficiency statute is that we're dealing with a moment in time. At all times before this moment (even the moment when the property first goes underwater), debt is recourse. The minute the lender's decision is made, it loses it's recourse character and becomes non-recourse per se.

I think Fogel's position, perhaps in part, is that we should not ignore the historical recourse nature of the debt just because of the lender's decision.

RexT2013 (talk|edits) said:

4 December 2013
Wiles, Dave Fogel runs a Yahoo group for tax professionals located in the Sacramento metropolitan area. That's how he told us about the Boxer letter and the letter he wrote to Chief Counsel.

Consider the following situation. In 2005, H&W buy a home in California for $300,000, get 80/20 financing (80% 1st mortgage, 20% 2nd mortgage, both nonrecourse under 580b). In 2006, they refinance both loans up to $400,000, and use the $100,000 in proceeds to buy two Mercedes cars. In 2007, they again refinance up to $500,000 and use the proceeds to buy a boat. The market crashes, they try to keep up the payments, and in 2011, they dispose of the home in a short sale for $200,000. $300,000 of the debt is canceled.

If the $500,000 debt is nonrecourse, then the selling price in the short sale is $500,000, resulting in a $200,000 gain, which is excludable under the home sale exclusion.

Do you really think that the IRS is going to allow these people to not pay any tax on the $200,000 of non-acquisition debt while at the same time allowing them to keep the Mercedes cars and boat?

Ckenefick (talk|edits) said:

4 December 2013
Even despite that good example, I'm still with Dave Fogel on this one. What the lender's decision boils down to is this one single idea: "We, the bank, will not pursue you, Mr. Borrower, even though we could." That does not make it non-recourse to me. If it did, then any secured recourse debt not subject to such provisions of 580(d) and/or 580(e) could, ostensibly, be non-recourse. Think about it. Let's say we're not dealing with 580: Lender has a secured recourse loan and forecloses and pretty quickly, and voluntarily, decides not to attempt to collect the deficiency. Might be that lender even tells this to the borrower in advance. This would be cast as a sale transaction and also as a COD transaction. Now consider a 580 situation: It's the same exact thing, really. Lender voluntarily decides to approve a short sale or to go the non-judicial foreclosure route. What's the difference between a voluntary, "We won't come after you" non-580 situation and a voluntary "We won't come after you" 580 situation? Nothing really...

Wiles (talk|edits) said:

23 January 2014
The CA FTB seems to be going along with the this. With all of its non-conformity, it seems strange that the CA FTB would not even try to put up a fight on this?

http://www.boe.ca.gov/members/runner/12-04-14-George_Runner.pdf

DAJCPA (talk|edits) said:

23 January 2014
Those with a large debt and low basis and who are would argue against the letter as well. Say single individual bought for 200K and has debt of 650K. Short Sale of 300K. Gain under this ruling is 450K with 200K of taxable gain after 121 exclusion which equals 40K+/- in tax. However, without this letter they have 100K gain (excluded) and 350K of COD income excluded under 108.

RexT2013 (talk|edits) said:

23 January 2014
DAJCPA, why would the COD income be excluded under 108? If insolvency, I get it. But if you're referring to the principal residence exclusion, seems like there's a lot of non-acquisition debt that would knock out the exclusion.

Doug M (talk|edits) said:

23 January 2014
DAJ-I understand where you are coming from the example you gave.

I do have a hard time understanding how a person can have pocketed $450,000 of refinance proceeds and not pay a nickel in tax for the non-acquisition debt relief. (oops, posted at the same time RexT posted, trying to open the pdf from Wiles.

DAJCPA (talk|edits) said:

23 January 2014
Yes, my example would only apply in certain circumstances such as in the case of insolvency.

EZTAX (talk|edits) said:

10 February 2014
So have folks decided how they are going to handle this? Of course the first COD to come across my desk this year is one where they will be possibly hurt by it. Out of work for a long time, lost their vacation home to short-sale that they had used as a piggy bank. (refinanced and took out equity). Last year when we had discussed the situation I had told them that since they were insolvent they would be OK. Now...

At a seminar I went to the speaker said that this was a "strange" situation. The IRS has not issued guidance other than a letter to a Senator. As was pointed out above, California has jumped on board although it usually takes them years to conform to IRS code. But where does that leave us?

This really get to me. Many of us have spent years trying to figure this out. The laws are complex, there is often a great deal of money on the table, and the forms are rarely correct. Just when we think we might understand it they pull the rug out from under us.

I agree with others above that have pointed out that taxpayer can mortgage property up to the hilt, short sale it, and keep the dough! Just does not seem correct.

RexT2013 (talk|edits) said:

10 February 2014
Last week, Dave Fogel sent out a message to Northern California tax pros with info about a 30-minute telephone conversation he had with an IRS attorney from the office that issued the letter to Senator Boxer. He said that they (the IRS) are concerned that the conclusion stated in the letter was wrong. According to Fogel, the IRS is going to spend more time researching California law. Fogel says that he thinks the IRS will either withdraw the letter or issue a revised one. Hope this helps you decide.

WEISSEA (talk|edits) said:

11 February 2014
"So have folks decided how they are going to handle this?"

The FTB has clearly said( see their website) they will honor the IRS letter. Since this affects only CA taxes(Fed PR exclusion still available for 2013), take them up on their offer until its recinded.

Seems to me the IRS commisioner can grant concessions even if they are wrong on the law.

EZTAX (talk|edits) said:

11 February 2014
Thank you both. That helps.

Dennis (talk|edits) said:

11 February 2014
The question that to my mind has neither been asked nor answered involves the tax consequence of a recourse obligation becoming non-recourse -- which is essentially the applicTION OF sEC. 580(e)

Makbo (talk|edits) said:

9 March 2014
CA short sale, 2nd home. 1099-C has "personally liable" checked, but taxpayer wants to take position that it has become a non-recourse loan due to CA anti-deficiency law. The IRS Chief Counsel letter and similar FTB Chief Counsel letter are not authority, as we all know, and may be revoked.

If so, understatement of income penalties could be substantial. Do you disclose the position on Form 8275, or similar statement? Put COD income on Line 21 and offset with a negative number? And as an aside, why in the heck doesn't Intuit's ProSeries support Form 8275? It's not like it would be hard to implement, it's just a glorified miscellaneous statement.

Taxmonkey (talk|edits) said:

9 March 2014
In my opinion, form 8275 would not be required because you would be disclosing the position that the debt should be treated as non-recourse by claiming it as gross proceeds of the sale. I also would not include it on line 21 for the same reason.

EZTAX (talk|edits) said:

26 March 2014
So - am I trying to hard here? Client's primary residence goes through foreclosure in California. Since it was a non-judicial foreclosure, it is my understanding that the lenders are not allowed to go after the client for the deficiency due to state law. Sounds to me much like the recent Boxer letter. So can I treat it as non-recourse loan?

DaveFogel (talk|edits) said:

27 March 2014
I don't know if you've been following what Rex posted above regarding the IRS's Information Letter, but if you decide to follow the IRS's position in that letter, you may be making a huge mistake. The people in the IRS office who issued the information letter have informed me that they are reconsidering their position, thinking that the information letter might be in error. On 2/26/2013, they sent me a letter confirming that the issue is still under consideration. As a result, I suggest that you disregard that letter in preparing your client's return.

Regarding your client's non-judicial foreclosure, suggest you read my article, “Does a Non-Judicial Foreclosure Convert Debt From Recourse to Non-Recourse?”. In that article, I analyze this theory and reject it. Under section 580d of the California Code of Civil Procedure, when the lender chooses to foreclose using the non-judicial foreclosure procedure, the lender can't later obtain a deficiency judgment, i.e., the balance of the debt is canceled by operation of California law. There's no conversion of a recourse debt to nonrecourse.

EZTAX (talk|edits) said:

27 March 2014
Thanks for the response Dave. Yes I have been following the discussions closely. Also listened to your advice on reading the article several years ago when this mess started. Appreciate the feedback.

Tkelly911 (talk|edits) said:

30 March 2014
It will be interesting to see if the IRS decides to embarass a powerful US Senator, upon whose well-heralded announcement many thousands of taxpayers, real estate professionals and tax practitioners most likely relied. Not to mention the press that will at some future date surround the first taxpayer to be hit with a huge tax bill in an examination because they relied on their senator.

The IRS does not operate in a political vacuum, especially now, so the realization that Dave is right and Chief Counsel mis-stated the law must be causing further consternation on Constitution Avenue, especially after the last Congressional hearings a few days ago.

Ckenefick (talk|edits) said:

30 March 2014
I don't know if you've been following what Rex posted above regarding the IRS's Information Letter, but if you decide to follow the IRS's position in that letter, you may be making a huge mistake.

I agree, whether or not that Info Letter is retracted.

IRS would of course be embarrassing itself if it retracts the Info Letter, just like with Bobrow and the IRA Pub. But public perception is another thing. The Info Letter could be retracted prospectively, which would be fair, but you wonder if they'll do that, seeing that either way, it's just an interpretation, and you don't have certainty without some firmer guidance, like a court decision. Perhaps that's why they took Bobrow to court.

If there is any chance for the IRS to stick it to a taxpayer and to Congress at the same time, when that can be done based on "interpretation," the IRS will do it, at least when the enabler of the legislation was a Republican. Take the Whistleblower program, for example.

But I agree with Tkelly, there are a lot of politics at play. Congress is basically the IRS' boss, and you know how employer/employee relationships sometimes go.

Ckenefick (talk|edits) said:

30 March 2014
Then again, some conspiracy theorists might believe that the IRS issued that letter full knowing that the information was wrong...only to retract it later...

Frankly (talk|edits) said:

30 March 2014
It's a secret backdoor plan of the administration to extract more tax, penalties, and interest from the unsuspecting citizenry, give that Congress won't raise taxes. Boxer was lured into the trap and has unwittingly promoted it. Revealed on Fox News.

Wiles (talk|edits) said:

30 March 2014
Perhaps that's why they took Bobrow to court.

I think it's the other way around. Bobrow is taking the IRS to court with their erroneously interpretations of the tax code. I just wish he would tell us. He probably filed his original return showing as taxable. Then filed amended return reversing the tax and highlighted exactly what he did and how ridiculous the idea is.

Maybe he is planning the same thing here. I sure hope he owns some underwater property in CA, since his M O is to hang himself out to dry and not one of his clients.

DaveFogel (talk|edits) said:

30 March 2014
As I mentioned above, on 2/26/2014, Chief Counsel sent me a letter stating that this issue is still under consideration. The IRS has officially released this letter as Information Letter 2014-0002.

Ckenefick (talk|edits) said:

30 March 2014
I think it's the other way around. Bobrow is taking the IRS to court with their erroneously interpretations of the tax code. I just wish he would tell us.

Well, that's a pretty good point. You do wonder if he did it just to expose the ridiculousness of it all.

WEISSEA (talk|edits) said:

30 March 2014
Does the Commissioner have discretion to permit concessions to the Senator e.g. in the case of CA short sale?

Example, see Bogue T.C. Memo. 2011-164.

"We do not follow the Commissioner’s reasoning..... However, as it stands, the regular work location exception reaches a result similar to what the Court of Appeals for the First Circuit labeled “absurd” when it held ....... Nonetheless, we will treat the regular work location exception as a concession by the Commissioner."

Ckenefick (talk|edits) said:

30 March 2014
Does the Commissioner have discretion to permit concessions to the Senator e.g. in the case of CA short sale?

I don't know: Is that consistent with the IRS' mission statement?

Wiles (talk|edits) said:

30 May 2014
IRS retracted their previous letter

Senator Boxer wants more info

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