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Richard, Tax Attorney
Category: Tax
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Experience:  29 years of experience as a tax, real estate, and business attorney.
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Short sold our home last year. We have forgiven debt on this

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Short sold our home last year. We have forgiven debt on this house and using the insolvency form to lessen our liability. Do we qualify for and is it possible to "elect the Exclusion for sale of your main home"?
Hi! My name is XXXXX XXXXX I look forward to helping you!

Was this debt that was forgiven used to purchase or improve your home? Thanks.
Customer: replied 3 years ago.

It was a HELOC loan. We used $100k for improvements, but the remaining amount for other purchases $135k. We were forgiven $183k.

Customer: replied 3 years ago.

Thank you, XXXXX XXXXX a HELOC loan. We used $100k for improvements. the remaining $135k for other purchases. We were forgiven $183.5k.

Thanks for your reply. With regard to the insolvency exclusion, you qualify if immediately before the forgiveness your liabilities exceeded your assets. To help you calculate this, you would use IRS Publication 4681 which you can find at .

The portion of the debt you used for improvements would be excludable as forgiveness related to your principal residence. But under the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was $2 million or less. The limit is $1 million for a married person filing a separate return. Details are on Form 982 and its instructions. The debt must have been used to buy, build or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision. In some cases, however, other kinds of tax relief, based on insolvency, for example, may be available. See Form 982 for details.

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Customer: replied 3 years ago.

Thank you,

So with the $100k improvements is 42.55% of the loan amount. Does that mean of the $183.5k foregiven debt, $78.1k is no taxable?

Here's the way the IRS orders things when the principal residence exclusion applies to only a portion of the loan (

"Ordering rule. If only a part of a loan is qualified principal residence indebtedness, the exclusion applies only to the extent the amount canceled is more than the amount of the loan (immediately before the cancellation) that is not qualified principal residence indebtedness. The remaining part of the loan may qualify for another exclusion.

Ken incurred recourse debt of $800,000 when he bought his main home for $880,000. When the FMV of the property was $1,000,000, Ken refinanced the debt for $850,000. At the time of the refinancing, the principal balance of the original mortgage loan was $740,000. Ken used the $110,000 he obtained from the refinancing ($850,000 minus $740,000) to pay off his credit cards and to buy a new car.

About 2 years after the refinancing, Ken lost his job and was unable to get another job paying a comparable salary. Ken's home had declined in value to between $700,000 and $750,000. Based on Ken's circumstances, the lender agreed to allow a short sale of the property for $735,000 and to cancel the remaining $115,000 of the $850,000 debt. Under the ordering rule, Ken can exclude only $5,000 of the canceled debt from his income under the exclusion for canceled qualified principal residence indebtedness ($115,000 canceled debt minus the $110,000 amount of the debt that was not qualified principal residence indebtedness). Ken must include the remaining $110,000 of canceled debt in income on line 21 of his Form 1040 (unless another exclusion applies).

How to report the qualified principal residence indebtedness exclusion. To show that all or part of your canceled debt is excluded from income because it is qualified principal residence indebtedness, attach Form 982 to your federal income tax return and check the box on line 1e. On line 2 of Form 982, include the amount of canceled qualified principal residence indebtedness, but not more than the amount of the exclusion limit (explained earlier). If you continue to own your home after a cancellation of qualified principal residence indebtedness, you must reduce your basis in the home as explained under Reduction of Tax Attributes, next."
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Customer: replied 3 years ago.

Thank you so much! One more quick question:


On the Insolvency form: Part III Line 3b & 3c:


3b. Mortgages on real property, nonrecourse:

3c. Mortgages on real property, recourse:


We had a primary loan paid in full.

Part of the secondary load paid off, and the remaining forgiven.

Our current home has a primary loan.

Where do I put all three mortgages nonrecourse or recourse?


California is a non-recourse state with regard to purchase money loans. So, if your current loan was used to purchase your new home, it would be a non-recourse loan. On your short sale house, the first lien loan, if obtained to purchase the house, would have been a non-recourse loan. If it had been refinanced, then it would be a recourse loan. The HELOC would have been recourse. :)
Customer: replied 3 years ago.

Homes are in CA. For Federal taxes, same thing?


Yes...same thing...recourse or nonrecourse is determined at the state level. :)

Thanks so much for the positive rating and bonus! I appreciate your kindness and the opportunity to serve you!
Richard and other Tax Specialists are ready to help you
I just wanted to thank you once again for taking the time to rate me so positively! It means a lot!
Customer: replied 3 years ago.

You're very welcome. Thank you for your quick responses. Have a lovely day!

Thank you so much for the kind words! You too! :)

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