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Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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What are the tax consequences that a real property owner who

Customer Question

What are the tax consequences that a real property owner who is "underwater" face?
Submitted: 4 years ago.
Category: Tax
Expert:  bfc77usa replied 4 years ago.
Hi, below is your answer. Please let me know if you need additional details.


There are a few tax consequences that a real property owner who is underwater faces. One of the primary concerns focuses on potentially unpaid property taxes for which a lien will exist on the home. If the homeowner can’t afford the payment they likely can’t also afford the property tax as well. While there were a number of programs implemented to help those who are underwater in their loans there is a potential huge tax consequence. If a bank forgives a certain amount of the principal there could exist a tax liability equal to the amount of debt forgiveness. Assuming 100,000 in taxes were removed from the principal balance the property owner could potentially owe taxes on that 100,000 and it would be treated as regular income. In that case the owner has a potentially lower payment but a huge tax liability that they ultimately can’t afford which could potentially end in foreclosure of the property.
Customer: replied 4 years ago.
This a tax question. I am unsure why this was sent to Business and Finance homework.


"Assuming 100,000 in taxes were removed from the principal balance the property owner could potentially owe taxes on that 100,000"

I am unclear what you mean by 100,000 in taxes were removed.

Aren't there tax consequences if the property is foreclosed upon?

Aren't there tax consequences if the property owner abandons the property?

If the real property is the owner's primary residence, there is a $250,000 exclusion for those with a single filing status and a $500,000 exclusion for those who are married filing joint.
There are also exclusions if the property owner files bankruptcy or is

Please elaborate.
Expert:  Lev replied 4 years ago.

Hi Diana and welcome to Just Answer!
Please allow me to assist.

"Underwater" generally means the mortgage balance outstanding is more than the fair market value of the property.
As long as the owner continue to pay mortgage - there is no specific tax consequences. If the difference is relatively small - that might be the best - to continue mortgage payments.

The owner might be reluctant to pay for the property more than it worth.
If the owner is not able to keep current with mortgage payments or if the difference is large - there is an option to negotiate with the creditor and reduce the mortgage balance. There are several mortgage modification programs. The amount of reduction will be reported as forgiven debt if that is a recourse mortgage and may be excluded from taxable income as long as that is a primary residence - however the form 982 would be required with the tax return. If that is not a primary residence - the debt forgiven might be excluded under other exemptions - for instance is the taxpayer is insolvent. If none of exemptions could be used - that amount is taxable as ordinary income - reported on form 1040 line 21.

Another issue to consider - if the property was refinanced with cash-out and that amount was not used for improvement of the property - but was used for other personal purposes. That amount might not be excludable under provisions of the Mortgage Forgiveness Debt Relief Act of 2007.

A short sale is another option and would be require an approval of the creditor. If the creditor forgives the remaining balance - it is reported as a forgiven debt of form 1099C - and all consequences above are in effect.
When the forgiven debt is excluded from taxable income - there are certain tax attributes which must be reduced - most often - that is a reduction of the basis. That might result with a recognized gain on that sale.
However - if that a primary residence - it may be excluded from taxable income under section 121. If the full gain is excluded - the sale transaction is not required to be reported on the tax return.

In many situations it would not be easy to get creditor's approval for the short sale. Sometimes approval process takes long - and a potential buyer would not agree to wait.
In this case - the owner might simply stop mortgage payments and let the property to be foreclosed. Or the owner just abandons the property.
In both situations - it would be considered as the sale at the fair market value. The creditor reports such transaction of form 1099A, Acquisition or Abandonment of Secured Property. That form reports the FMV and the amount of mortgage balance, but doesn't tell anything if that balance is forgiven.
If the balance is forgiven - the form 1099C is issued. If the balance is not forgiven - depending on the local law - the debt becomes not secured - and the creditor might pursue collection actions.

See for reference
Home Foreclosure and Debt Cancellation -
Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments -
Form 1099C, Cancellation of Debt -
form 1099A, Acquisition or Abandonment of Secured Property -

Lev, Tax Advisor
Category: Tax
Satisfied Customers: 29941
Experience: Taxes, Immigration, Labor Relations
Lev and other Tax Specialists are ready to help you
Customer: replied 4 years ago.
Thanks Lev.