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I own a single family residence in Arizona and it is on less

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than 2.5 acres.  I only...
I own a single family residence in Arizona and it is on less than 2.5 acres.  I only have one loan, and it is the loan that was taken to purchase the property. The loan has never been refinanced. I lived in the home for 2.5 years, then transferred out of state. I have continued to pay the mortgage although I have not lived in the house in 3 years. I can no longer afford to continue to pay the loan. I was considering a short sale, but I have read that a foreclosure may be better in my situation due to the tax consequences. If I short sale there would be tax liability on about 90K, if I let the bank foreclose there would be no tax liability (I would take a capital loss) but my credit worthiness would be gone. I am not insolvent (no liquid assets, no other home, just retirement accounts). Any suggestions on the best move to make??  Short sale or foreclosure?  If I do a short sale, is there anyway around the tax?
Submitted: 6 years ago.Category: Tax
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3/1/2011
Tax Professional: Wallstreet Esq., Tax Attorney replied 6 years ago
Wallstreet Esq.
Wallstreet Esq., Tax Attorney
Category: Tax
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Wallstreet Esq. :

Hello I am a licensed attorney here to help you with your question, please review my response and do not hesitate to ask for clarification.

Wallstreet Esq. :

A Short sale would be better, as a foreclsoure, would hurt your credit score, and the amount cancelled would be significantly more.

Wallstreet Esq. :

If you cannot file insolvency or file bankruptcy, your only option would be to offset the cancelled debt with losses incurred by the property.

Wallstreet Esq. :

If you make an election to exclude canceled qualified real property business debt from income, you must reduce the basis of your depreciable real property (but not below zero) by the amount of canceled qualified real property business debt excluded from income. The basis reduction is made at the beginning of 2010. However, if you dispose of your depreciable real property before the beginning of 2010, you must reduce its basis (but not below zero) immediately before the disposition. Enter the amount of the basis reduction on line 4 of Form 982.

Wallstreet Esq. :

If you sell an investment property for a loss, your loss may be deductible against your income. Investment properties are treated very similar to equity investments in this regard. You will need to fill out IRS form 4797 in order to claim your losses.




Wallstreet Esq. :

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Customer:

The property isn't an investment property, unless it converts to an investment since I cannot live in it. Since the loan is non-recourse I thought foreclosure would be the only option if I wanted to avoid cancellation of debt income.

Wallstreet Esq. :

If you have never reported or converted the property to an investment property, either a short sale or foreclosure would discharge any cancellation of debt you recieve.

Wallstreet Esq. :

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.

Wallstreet Esq.
Wallstreet Esq., Tax Attorney
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Customer reply replied 6 years ago

You wrote: If you have never reported or converted the property to an investment property, either a short sale or foreclosure would discharge any cancellatoin of debt you receive.

 

I really want to know if this is the case in my situation. The loan is a non-recourse loan, so I understand if the bank does a trustee sale then there is no cancellation of debt income. I want to try to save my credit by doing a short sale, but I am told I do not qualify for the Qualified Principal Residence exclusion because I haven't lived in the home as my Prinicpal Residence in 3 years, the home is not a rental, and I am not insolvent to the extent of the debt forgiven.

 

I just cancelled the short sale because I was told I do not qualify for any of the exclusions in the Mortgage Debt Forgiveness Act, can you please tell me which provision would I fall under? The cancelled amount would be about $90k.

Tax Professional: Wallstreet Esq., Tax Attorney replied 6 years ago

The property could be considered your primary residence even now, I would change your license and address of your tax return to make it a primary residence, by not having any evidence that you lived their or used the property recently it would be considered an investment or second home. You could qualify and I would prepare in advance to qualify.

 

relevant factors in determining a taxpayer's principal residence, include, but are not limited to:

(i) The taxpayer's place of employment;
(ii) The principal place of abode of the taxpayer's family members;
(iii) The address listed on the taxpayer's federal and state tax returns, driver's license, automobile registration, and voter registration card;
(iv) The taxpayer's mailing address for bills and correspondence;
(v) The location of the taxpayer's banks; and
(vi) The location of religious organizations and recreational clubs with which the taxpayer is affiliated.

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Customer reply replied 6 years ago
Thank you Wallstreet Esq. The property is in Arizona and I now live in California. My California drivers license does list an Arizona PO Box, but I would not be able to go to AZ to obtain an Arizona license.

If I listed the Arizona address on the Fed and California State tax returns, would the State of AZ look for me to file state taxes there too?

If I can't qualify for the Primary Residence exclusion, how long would I have to rent it out before it is considered a rental for purposes of the Qualified real property business indebtedness exclusion that you referenced earlier? Is it as simple as me getting someone in there, collecting money and calling it a rental or would I have to go through the appropriate agencies to convert the property type to a rental?

Or, would the easy way out be to allow the foreclosure to happen. I am currently 45 days past due. Since the loan is non-recourse I am told there would not be cancellation of debt income.
Tax Professional: Wallstreet Esq., Tax Attorney replied 6 years ago
AZ, would require you to file a return, as you would be an Arizona resident, however your State taxes paid in CA will usually wipe out any tax you would owe.

To consider it a rental property their are no forms to file per se, but you would have to show the property is actually to use it as a rental, meaning renting it out, and depreciating the property or claiming deductions on the property as a real estate investment.

The following are typical tax deductions you should start claiming:

The actual cost of a house, apartment building, or other rental property is not fully deductible in the year in which you pay for it. Instead, landlords get back the cost of real estate through depreciation. This involves deducting a portion of the cost of the property over several years.

The cost of repairs to rental property (provided the repairs are ordinary, necessary, and reasonable in amount) are fully deductible in the year in which they are incurred. Good examples of deductible repairs include repainting, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows.

Landlords are entitled to a tax deduction whenever they drive anywhere for their rental activity. For example, when you drive to your rental building to deal with a tenant complaint or go to the hardware store to purchase a part for a repair, you can deduct your travel expenses.

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