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A second is owed on a house, and there is little or no equity

A second is owed on...
A second is owed on a house, and there is little or no equity to pay it. The second is a line of credit that was taken out against the house for purposes other than remodeling (money used on other things).

Is there an exception to the law of allowing the homeowner to have no taxes due upon forgiveness when funds were not used to remodel/purchase? Home was owned as principal residence for 15 years, but vacant last 14 months (rented three months in the middle of those 14).

any difference between it being sold on shortsale and it being foreclosed upon?

details: home purchased in 2000 with 100% proceeds from prior home and $150K in remodeling. All cash.
Mortgage 1st and 2nd taken in 2005 with money used for other things.
mortgage is $2.1m. shortSale proceeds with take out first for $1.5 ($150K of which are past dues taxes, bank costs, broker commissions etc) and $50 toward $750K owed on 2nd.

If foreclosed, likely sale: $1.5 also.
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Answered in 8 minutes by:
9/17/2013
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,719
Experience: Taxes, Immigration, Labor Relations
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Lev :

Hi and welcome to Just Answer!
It is possible that the line of credit is a non-recourse loan.
A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.

Lev :

An exclusion provided by the Mortgage Forgiveness Debt Relief Act may not be used in this case.
The Act applies only to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes. In addition, the debt must be secured by the home. This is known as qualified principal residence indebtedness.
Because the loan was not used for these purposes - that type of exclusion may not be used.
Another exemption might be possibly used - Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.You are insolvent when your total debts are more than the fair market value of your total assets.Insolvency can be fairly complex to determine and the assistance of a tax professional is recommended if you believe you qualify for this exception.

However - because you are in California - I believe that is a non-recourse loan - and the form 1099C would not be issued. And as we already mentioned - forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.

Customer:

i checked: not non-recourse. Is what the sibling is trying to do insane? My feeling is it's interfering with divorce settlements. On the other hand, I'm assuming that a lien holder can ask for anything he wants, reasonable or not.

Customer:

QUESTION: If what he's asking for is ridiculous and so incredibly unlikely based on the past of all cases, then the other trustee will likely overule the sibling and simply release the liens. If there's some logic to what he's trying to do (such as there have been lawsuits in the past attacking someone for releasing a lien), then I don't know. AGAIN: he's taking the position that he is putting himself in jeopardy of being sued by the couple that WANTS him to release the lien such that the property doesn't go into foreclosure. Forcing them to go hire attorneys and write him a release seems ridiculous. Or am I wrong?

Lev :

Please let me some time to reply...

Customer:

Hi: No worries. Actually, I'm not sure I originally asked you the question about the sibling. What's happening is that there are liens on the house. The lien holders for a couple thousand each are releasing them (not vacating them). The hold out is sibling of Husband who has a track record of messing with the Husband. I'm looking for a moral and legal answer. legally, does he actually have to worry about homeowners suing him for releasing a lien that will allow their home to be short saled and not forclosed on? Have you ever heard of a suit like that? By moral, husband will go to the family if this is as ridiculous as it sounds

Lev :

If that is a non-recourse loan - the situation would be different...
Unfortunately - that means - an exclusion provided by the Mortgage Forgiveness Debt Relief Act may not be used...
So the only option would be to claim an insolvency exemption.
If that is not available - there is nothing may be done - and the amount reported on 1099C will be taxable income.
If your debt is secured by property and that property is taken by the lender in full or partial satisfaction of your debt, you are treated as having sold that property and may have a taxable gain or loss. The gain or loss on such a deemed sale of your property is an issue separate from whether any cancellation of debt income associated with that same property is includable in gross income.


If you receive a Form 1099-C but the creditor is continuing to try to collect the debt, then the debt has not been cancelled and you do not have taxable cancellation of debt income.

Lev :

A lien is the legal claim against your property when you neglect or fail to pay a debt. The lien protects the creditor’s interest in your property, including real estate, personal property or financial assets.
When the property transferred to another owner - the levy still attached to that property and any liability will be transferred to a new owner. If the lien is released - that means you may sell teh property without contacting the lien holder - but that doesn't mean the debt is illuminated - as long as the debt is valid - the creditor may try to collect the debt and a new lien may be recorded.

Customer:

do you have an opinion on this:

Customer:

Hi: No worries. Actually, I'm not sure I originally asked you the question about the sibling. What's happening is that there are liens on the house. The lien holders for a couple thousand each are releasing them (not vacating them). The hold out is sibling of Husband who has a track record of messing with the Husband. I'm looking for a moral and legal answer. legally, does he actually have to worry about homeowners suing him for releasing a lien that will allow their home to be short saled and not forclosed on? Have you ever heard of a suit like that? By moral, husband will go to the family if this is as ridiculous as it sounds

Lev :

Generally - creditors allow short sale because the sale price would be better compare to foreclosure and there is no need to resell the property after it foreclosed (means less additional expenses).
And short sales are subject of lender's approval.
Additional liens (might be based on judgments, mechanical or contractor liens, etc) have lower priority and sometimes are not paid if all proceeds are used to pay higher priority liens like mortgage lenders.
So if that is a low priority lien - releasing it might make no difference as it is questionable if that lien would be ever paid, but allows the owner to get better selling price via short sale and avoid foreclosure.
I do not see any legal issues - the lien holder has the right to release the lien. However not being a legal expert - you might want to discuss legal accepts with the attorney preferably in your state.
As moral aspects - I personally always avoid any business transactions with family members, do not charge family members for my services and do not pay for any help I received from family members.
But that is my personal position. Sorry for your situation.

Lev
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