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Ellen, Tax Attorney
Category: Tax
Satisfied Customers: 36714
Experience:  25 years of experience helping people like you.
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I bought a condo 5 years ago and had lived in it as my primary

Customer Question

I bought a condo 5 years ago and had lived in it as my primary residence. Just about a little over a year ago I bought a bigger house and used this house as my primary residence. Because of this I had rented out my condo but after 7 months, I couldn't afford to meet the mortgage anymore so now it is foreclosing. Five years ago I bought it for $195K and now owes $165,000 on it. It's current value now is about $60K, if that. My lender is having it auctioned in a few weeks. If it auctions for $50, this will leave me a balance I still owe of $115K.

Since this property is now considered my investment property, will I have to pay taxes on $115K on my 2011 for negative income? Is there Debt forgiveness apply to me at all? Or is this just for primary residences only?
Submitted: 6 years ago.
Category: Tax
Expert:  Ellen replied 6 years ago.

You can be taxed on the relief of indebtedness income. If the lender accepts less than what you owe on the full balance, this difference will become discharge of indebtedness income and it is taxed as “ordinary income” (See 26 U.S.C. § 61 and §§ 1001 through 1016).

Here are the common exceptions to the IRS discharge of indebtedness income rule. There may be other exceptions as well. You can determine if any apply to your situation.

Common Exceptions:

1. Debts discharged through bankruptcy are not considered taxable income.

2. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.

3. Personal residence. The Mortgage Forgiveness Debt Relief Act of 2007 excludes from taxation discharges of up to $2 million of indebtedness that is secured by a principal residence and is incurred in the acquisition, construction or substantial improvement of the principal residence.

4. If you are insolvent when the debt is canceled, some or all of the canceled debt may not be taxable to you.

I hope that this helps.
Ellen, Tax Attorney
Category: Tax
Satisfied Customers: 36714
Experience: 25 years of experience helping people like you.
Ellen and 3 other Tax Specialists are ready to help you
Customer: replied 6 years ago.
Say I consider this to be my primary resident and therefore the IRS is going to exclude me from taxation, will the lender still come after me for the difference of what I still owed?

If I do get taxed on this negative income by IRS or lender does come after me 5 years later, can I just file for bankruptcy to release me the burden of paying this debt? I"m hearing lenders will likely come after borrowers even if the short sale was approved initially.
Expert:  Ellen replied 6 years ago.
What state is the property located in?
Customer: replied 6 years ago.
Expert:  Ellen replied 6 years ago.

It is possible that a deficiency may be entered however it is unlikely. Here is why.

In CA deficiency judgments can not be entered for foreclosures by private sale or on purchase money mortgages.

Most foreclosures in CA are nonjudicial. If the foreclosure was nonjudicial, a deficiency judgment cannot be entered against you. The lender then would take the property in full satisfaction of the debt.

Deficiency judgments can be entered on judicial sales of non-purchase money mortgage. However even in judicial sales regarding non purchase money mortgages the lender will typically not pursue a deficiency judgment as it entitles the defaulting borrower a right to redeem his property if he can pay the necessary charges and cure his arrears.

In summary, deficiency judgments are not usually entered in CA, but in some narrow instances they can be.

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