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Dr. Fiona Chen
Dr. Fiona Chen, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 435
Experience:  Former IRS Revenue Agent
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As a 1st mortgage holder under a deed of trust in TN on

Customer Question

As a 1st mortgage holder under a deed of trust in TN on commercial property if I foreclose (non-judicial) and the sale does not bring enough to cover the mortgage balance do i get a tax write off (deduction)for difference between the mortgage balance and the sale price?
eg. mortgage balance is 300,000. and the foreclosure sale price is 200,000.
Or is it a capital loss that reduces capital gains just like a loss on a stock?
OR what is the tax consequence of this event?
I am not Bank but self financed the sale of a business property. i am cash basis.
Submitted: 6 months ago.
Category: Tax
Expert:  Dr. Fiona Chen replied 6 months ago.

Dear Customer,

There are several aspects to your question and situation before you can claim this capital loss on a tax return.

With a trust, you can sell the trust interest to another person or institute. The trust owns the title deed. You don't have to lose the property by selling it and taking the loss. A bank usually sells after foreclosure because it is in a bank, loan business and not in investing by real estate or rental business, etc.

The logic is this, similar to claiming a theft and casualty loss, we need to show that we have tried our best to recover the bad debt before we can claim the bad debt on our tax return. For theft and casualty, we need to show our efforts done trying to reduce the loss on our part.

For example, a) We need to go to court to go after the individual or institution who stop paying us on the payment due to the trust. We cannot just stop the effort. b) We need to show that we have tried all other alternatives such as renting the place out and selling the trust interest with the house to other people who are willing and able to keep the investment for a longer period than we can.

The IRS is not to be used as our recovery source. It is the last source to report the true situation and not to recover our losses.

If we have tried everything and we have to lose the house, we at least need to issue a 1099-C, debt cancelled to the other party, who failed to pay the trust, so that the IRS can go after him/her to collect from his income in this deal for cancellation of debt.

Also, your relationship to the deed of trust and with the person who occupied the house is very important. If you are related parties, you may not be able to take the loss. This loss could be interpreted as a gift because we let the person walking away.

Unless we are 100% sure that the debt cannot be recovered, we have tried everything possible, and this was at an arm's -length deal, etc. , we cannot claim capital loss. This is similar to running a business. To close it down, there are many aspects.

Please consult with publication 530 on how to calculate basis for your deed of trust.

https://www.irs.gov/pub/irs-pdf/p530.pdf

The IRS publishes an entire chapter from its Internal Revenue Manual on the issue of non-judicial and judicial foreclosure and their tax consequences if the owner of the property or the user of the property also owes to the IRS. It is highly recommended here that you consult with it and read it through even if there are points non-applicable to your situation. By reading through it, we can see how well developed, matured, and well defined the IRS has in its knowledge of non-judicial sales of real estate properties.

https://www.irs.gov/irm/part5/irm_05-012-004.html

The issue comes to the bot***** *****ne is this. No owner or investor will voluntarily say, O.K., let me lose out on 100,000. That is fine. On the tax return, a capital loss is only allowed for (3,000) per year. So, this person will take 33 years or more in order claim that capital loss. The behavior is unreasonable. Therefore, there are many, many circumstantial evidence will have to come in to substantiate the deal, the capital loss of 100,000.

For example, how many other properties this person has had in similar deal, why was the deed of trust established to start with, and why it was not a mortgage sale if it was with a deal between parties of at-arm's-length. Is this deal to allow the true owner of the property to take capital loss on the sale of a principle residence when a regular taxpayer cannot take such a loss on the tax return, etc.

Please feel free to follow up.

Regards,

Fiona Chen, MPA, Ph.D., CPA, ABV, CFF, CITP