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Lane
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4188
Experience:  Providing Financial, Tax & Business advice since 1986
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I just got a principal reduction on my one and only primary

Customer Question

I just got a principal reduction on my one and only primary residence (in Florida). What are the current rules on whether that gets reported as income? Amount forgiven was more than $250k but less than $500k if that makes a difference.

Also.

I am on the loan, but own the house with my brother who is NOT on the loan. Since we are both owners, can one of us tax the entire tax burden on ourselves if we opted to?
Submitted: 1 year ago.
Category: Finance
Expert:  Lane replied 1 year ago.

Lane :

Hi, as long as this was your residence, you will not owe tax.

Lane :

The Mortgage Forgiveness Debt Relief Act survived the fiscal cliff when it was given a one year extension through 2013. Homeowners who sell their primary residence in a short sale or lose their home to foreclosure or have debt reduced through negotiation will not have to pay taxes on the loss up to $2 million ($1 million if married filing separately)

Customer:

Awesome.

Customer:

Thank you!

Customer:

Are you very familiar with HAMP and the PRA (Principal reduction alternative)?

Lane :

not intimately BUT what the debt forgiveness turns on is the fact that it's your principla residence, you home, rather than the process for the forgiveness

Lane :

waiver of taxation on debt forgiveness

Customer:

Cool. I am trying to figure out what my options are as far as selling the home to be done with it... I'll see if another attorney has some background with that...

Customer:

Thank you for answering my initial question tho! :)

Lane :

THanks, XXXXX XXXXX IRS guidance on the tax forgiveness piece:

Lane :

The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.

This provision applies to debt forgiven in calendar years 2007 through 2013. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

Lane :

I CAN tell you that as long as it's considered a short sale )among other things)_ the tax IS waived

Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4188
Experience: Providing Financial, Tax & Business advice since 1986
Lane and 3 other Finance Specialists are ready to help you
Expert:  Lane replied 1 year ago.

Thanks much Clyde.

For your documentation:

http://www.irs.gov/Individuals/The-Mortgage-Forgiveness-Debt-Relief-Act-and-Debt-Cancellation-

Lane
Customer: replied 1 year ago.

Hey Lane. Had another question.


 


I didn't get a chance to have you elaborate. Does the debt forgiveness only apply to me since I was on the loan? Meaning, can my brother be the one that reports it on his taxes (the 1099-c). Or is it because the loan is in my name only, I am the only one allowed?


 


Also. If I am not currently living in the home, but it was bought as a primary and lived in as a primary for 3 years, that still counts under the debt forgiveness?

Expert:  Lane replied 1 year ago.

Hi Clyde,

The debt forgiveness does only apply to you if you were the only one on the loan.

To state is rather bluntly, only the person who HAS the debt can have the debt forgiven.

My guess is that it's your social security number that's on the 1099. (And that's a IRS sees .. a 1099 with someone's social security number on it)




On the primary residence? NO problem there ... You only have to live in the home for 24 months (any 24 months, doesn't even have to be consecutive) out of the last FIVE years, for it to qualify as your primary residence.

You are fine.


Let me know if you have questions...

Lane

Customer: replied 1 year ago.

What if you buy the house as a primary, live in it, then move and didn't live in it for 24 months total? What if your job required you to move?


 


Or. What if you buy the house, are on the loan, live in it with someone else, you move, but they maintain it as a primary residence. Would that still count?


 


 

Expert:  Lane replied 1 year ago.


Here are the IRS guidelines on this.

They even provide some examples.

What matters is (1) ownership and (2) use.

See this:

http://www.irs.gov/publications/p523/ar02.html#en_US_2012_publink1000200713

Just remember that if someone else owned it with you that's ok ... and if someone else lived there with you, that's ok too.

It's just ... did you own it for 2 yrs and ... did you live there for 2 years

Hope this helps

Lane

Customer: replied 1 year ago.


When you say 'you', do you mean whomever is on title?


 


My brother and I are on title, have been since 2008. I lived there some, he lived there primarily for almost 4 years.


 


So even though he isn't on the loan and I am, because it was his primary for so long, the debt is included?

Expert:  Lane replied 1 year ago.
OK,

What we are talking about is the requirements for passing the test as this being YOUR primary residence. (owning and living there for 2 out of the last 5 years) ...

Which is one of the requirements for the tax on your debt forgiveness being waived.


As I said above someone else owning it with you is irrelevant.

The 1099 came to you right?


Customer: replied 1 year ago.

Not yet. But it's coming. It's a lot. The taxes owed on it would be more than I make in 4 years (seriously). It's one of the largest reduction anyone has ever seen - which is a good thing. But not if I have to pay taxes on it. I'll be screwed.


 


The IRS publication you sent me to, that's for short term capital gains exclusions yes? The same things apply?

Expert:  Lane replied 1 year ago.

That's right.

The requirement to define the home as being your PRIMARY RESIDENCE (the main requirement for having the tax waived on debt forgiveness) ...


IS


... the very same requirement for having the gains excluded n SALE of a "PRIMARY RESIDENCE."




Same exact test.

The law is actually worded that way, to use the same exact test:

(5) Principal residence.--For purposes of this subsection, the term “principal residence” has the same meaning as when used in section 121.

26 U.S.C.A. § 108 (West)





Customer: replied 1 year ago.

How about the insolvency factor if this ends up not being excludable?


If I am 100% insolvent, the debt is not taxable yes?

Expert:  Lane replied 1 year ago.

Doesn't matter.

See this:

C) Principal residence exclusion takes precedence over insolvency exclusion

26 U.S.C.A. § 108 (West)
Customer: replied 1 year ago.

I thought the insolvency rule was there to protect individuals who didn't qualify otherwise.


You saying that's not accurate?


 

Expert:  Lane replied 1 year ago.

NO, that's exactly what I'm saying

Primary residence takes precedence.

Then if you don't qualify for PRINCIPAL RESIDENCE (which means just filling out a line or so on the 982).

THEN, you must meet the insolvency test which you must prove by attaching asset statements, retirement plan balances, other assets, other debts, etc
Customer: replied 1 year ago.


Ok, I got you.


 


I just did the insolvency worksheet... Total liabilities were around $650k. FMV of assets was around $240k, so a difference of $410k.


 


Did I read this worksheet right in assuming that it would make me insolvent?


 


I was reading the IRS publication and it just wasn't clear, so I did the worksheet. The part that I misunderstood was the partial insolvency part about the debt being forgiven being more or less than the amount of insolvency and if that's the case, some of the debt has to be included?


 


I know we are getting off scope here, but it's 730 at night and I wont be able to talk to anyone until Monday so I am trying to get a little better idea so the weekend isn't spent with me thinking I will owe the IRS $150k.

Customer: replied 1 year ago.


Publication 4681 states that if the amount of insolvency is more than the amount of the debt that was cancelled, you can exclude the entire amount. That appears to be the case here almost dollar for dollar.

Expert:  Lane replied 1 year ago.
sOK ... I'm here.

Yes, the amount of your insolvency (assets minus liabilities) is the amount of debt forgiveness that you will not have to pay tax on.
Expert:  Lane replied 1 year ago.


Maybe better said, ...

If the amount of your liabilities MINUS the amount of your assets, is more than the amount of forgiven debt, then it is all waived.
Customer: replied 1 year ago.


Does the amount of insolvency have to be MORE than the amount of the debt forgiven?


 


I think being insolvent is one thing, then being insolvent and trying to exclude debt is another. In this particular instance, the amount of insolvency would have to be greater than the debt forgiven for me to not owe taxes on it.


 


And the rule is SPECIFIC to the value of everything immediately prior to the cancellation. So if the debt is cancelled Tuesday. Then I use all the figures from Tuesday. Doesn't matter if the house is worth more six months from now and we sell it for a profit. It only matters at the time the debt is forgiven...


 


Thanks for getting in such depth with me... I really appreciate it.

Expert:  Lane replied 1 year ago.


Here's the way IRS puts it:

" Normally, you are not required to include forgiven debts in income to the extent that you are insolvent."

This is from here:

http://www.irs.gov/Individuals/The-Mortgage-Forgiveness-Debt-Relief-Act-and-Debt-Cancellation-




Yes, you have it... the insolvency is measured on the date the debt is forgiven.

And remember it's not "We forgive the tax on forgiven debt IF you're insolvent," ... It's "We forgive tax on the forgiven debt TO THE EXTENT that you are insolvent."

For example, if your liabilities exceed your assets by 200,000, but you have 250,000 of forgiven debt, then you will still have to pay tax on 50,000 of that forgiven debt as if it's income.

Customer: replied 1 year ago.

Got it. Just from doing this worksheet, it would appear, that even though the amount forgiven is very high, the entire amount would be forgiven.


 


One last question.


 


Have you ever seen or heard of someone being audited on just that issue alone in regards XXXXX XXXXX cancelled debt? Especially when it has to do with property and the financial collapse?

Expert:  Lane replied 1 year ago.

NO, I honestly have not.

SOOO many of these have gone through.

The worst I seen is a request for a statement from a 401(k) account that was AS OF the day in question, and this person was VERY close.

If the amount is clearly over, my guess is that you will not hear from them on this.

Customer: replied 1 year ago.

I lied. One last question. ;-)


 


The value of the piece of property that has the debt being forgiven, who determines it's value immediately before cancellation? Would the value be the amount left on the unpaid principal balance AFTER it had been reduced? IE: If they reduce from $200k, to $100k, would the value that day be $100k?

Expert:  Lane replied 1 year ago.


No, the value is Fair market value (as will all other assets)
Expert:  Lane replied 1 year ago.


Clyde,

Does that get you there?

I have a daughter that I need to kiss and put to bed.

Won't be on for a while

WILL be checking back in in an hour or so

Lane
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4188
Experience: Providing Financial, Tax & Business advice since 1986
Lane and 3 other Finance Specialists are ready to help you
Customer: replied 1 year ago.
Oh. I'm sorry. I had to step out. Yes, please. You helped immensely. :)

Anyway to make this question private?
Expert:  Lane replied 1 year ago.


Hi Clyde,

Back now...little one kissed.

NO, sorry the questions are public HOWEVER, we never allow identifying information such as phone numbers or email addresses.

The system automatically XXX's them out.

Anonymity is a requirement of our terms of service and if someone wants to give a first and lase name, the assumption is that it's a pseudonym.

Given that we've not discussed specific numbers etc. I wouldn't worry.

...sounds like you've "got your arms around the situation."



Lane



If this HAS helped I would appreciate positive feedback of a 3(ok) or better. (That's the only way I'll be paid for my time)

However, if you still have questions on THIS issue. please come back here, so you won't be charged for another question.
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 4188
Experience: Providing Financial, Tax & Business advice since 1986
Lane and 3 other Finance Specialists are ready to help you

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