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Does one need to pay the IRS for a forclosure of a home?

Customer Question
does one need to pay...
does one need to pay the IRS for a forclosure of a home?
Submitted: 9 years ago.Category: Tax
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3/3/2008
Tax Professional: Ed Johnson, Tax Preparer replied 9 years ago
Ed Johnson
Ed Johnson, Tax Preparer
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Dear *****,

This depends on the nature of the forclosure and what the home eventually sells for.

In theory, if the FMV of the home, which is generally determined to be the sale price of the home, is less than the mortgage loan, the bank forgives the loan. Forgiven debt is normall reported on schedule C and is considered taxable income.

it is also possible, if your home was refinanced, that you could also incur a capital gain. Capital gains exposes you to capital gains tax. However, in a majority of instances, the rules for taking the capital gain exclusion , would be applied, and you would end up paying no capital gains tax.

In addition, under the new Mortgage Relief Act, you are entitle to attempt to relieve any tax debt created by a forclosure by completing the following form.

http://www.irs.gov/pub/irs-pdf/f982.pdf

This form essentially reduces attributes so that you can elimiante in part or in whole, all forgiven debt to the extent of insolvency so that you do not pay taxes as a result.

Ed Johnson
Ed Johnson, Tax Preparer
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Customer reply replied 9 years ago
Ed this would apply to a second home, not my primary home, right? I can be considered insolvent and still have my primary home? Is there a way to fill out the form and find out whether the government views me as insolvent or not.

As far as capital gains goes, I remortgaged the second home to put an addition on my primary home. However, we built our second (retirement) home for $140K and the house was recently appraised for $289. The Capital Gains would be on the difference, right? But, you said I probably would not have to pay that. Could you please explain a little more about why not?

Also, I understand that Congress is considering signing a bill that would rescind the "debt forgiveness" tax (form 1099C)....do you happen to know anything about that and if they are really supposed to be doing this and when??

Thank you so much for all your help.

Nancy
Tax Professional: Ed Johnson, Tax Preparer replied 9 years ago

Dear ***** *****all,

the debt bill was actually passed; it is called the .The Mortgage Forgiveness Debt Relief Act of 2007

http://www.whitehouse.gov/news/releases/2007/12/20071220-3.html

The form that I linked you to was modified last month by the IRS to allow homeowners to comply with the act.

So where line 1 e is for principle residnece, you may include other debt that is not a priciple residence on anothe line. Read the instructions carefully for other debt that is non-business debt. They give an example of a car, but those items listed are examples and not inclusive. Use it for the second home.

Additionally, if any of the debt for the second home was used to "improve or extend the value of the primary residence, that portion of the debt goes on line 1 e.

You can have a degree of insolvency which caused a lien to be forclosed on. You can avoid paying taxes on forgiveness of debt to the degree of insovency. So it is possible to still have some insolvency and still retain your home at the time of the forclosure on the second home.

When i stated that you could avoid capital gains tax, it was assuming you had a forclosrue on the primary residence. Your initial question that i respondided to did not contain this bomb.....so i gave a response on primary residence, and suddenly it is your second home and now my answer has to change slightly.

You are entitled to a maximum capital gains exclusion if you both owned the home and lived in it as your primary residence for at least 2 of the past five years. The time spent in the home does not have to be continuous. So you can add up say, 1/4 yaers or half years over the course of 5 years to total 2 years, in order meet the maximum capital gains exclusion from taxes. That maximum exclusion is 250,000 of capital gain if filing a seperate or single return, and 500,000 if filing a joint return. If you lived in the home as your primary residence (yes even the second home) less than the 2 years and was required to sell it because of unforseen circumstances you can take a porportional reduced capital gains exculsion form taxes.

Unforseen circumstances are:

  1. death
  2. health
  3. natural and manmade disasters
  4. change in financial circumstances such that you can not afford the mortgage
  5. change in job or financial circumstances such that you may not afford to pay the mortgage and still meet basic living requirements.
  6. change in job location that meets safe harbor requirements
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