Tax implications of foreclosure sale

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ArthurWankspittle
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Tax implications of foreclosure sale

Postby ArthurWankspittle » Tue Apr 12, 2011 10:21 am

I hope you won't mind me asking you about the following situation, as I'm sure your replies will more accurate than the guesses others following the story are coming up with.
The situation with all figures rounded for easy calculation:
California, so non-judicial foreclosure.
Foreclosure auction today, starting bid set at $120,000. Reasonable chance someone will buy at this price to flip it. Also reasonable chance it will go back to the bank.
Debt $320,000. Has been re-financed, HELOCed and re-financed several times. I believe the last re-financing was a re-mortgage, replacing other mortgage, loan and HELOC.
Question is, what happens to the shortfall of $200,000? I don't think it is discharged by one of the homeowner forgiveness schemes as it has been re-financed too much, but is there "part" forgiveness? Does the lender write off the $200,000 and issue a 1099 to the borrower?
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Re: Tax implications of foreclosure sale

Postby Judge Roy Bean » Tue Apr 12, 2011 2:48 pm

ArthurWankspittle wrote:...
Question is, what happens to the shortfall of $200,000? I don't think it is discharged by one of the homeowner forgiveness schemes as it has been re-financed too much, but is there "part" forgiveness? Does the lender write off the $200,000 and issue a 1099 to the borrower?


The "lender" may not be involved. It is possible the latest creditor in the long string of loans and transfers is the trustee of the REMIC-based trust who relies on the servicer or special servicer to engage a local law firm to foreclose.

It is also possible that the "lender" is defunct and/or bankrupt and the loan is simply an asset being managed under receivership. It could have been sold to another entity at a substantial discount. What the real "loss" (if any) is involved becomes a question some entities can't/don't want to answer. The reality is, if they issue a 1099, their books are going to have to reflect the exact same treatment for that particular loan/account. The way servicers pull numbers out of their ***es on loan balances, that can be problematic.

Thus, the decision to issue a 1099 is clouded, to say the least. HOWEVER, in the Economic Stabilization Act the exemption of up to $2M of "forgiven" debt on someone's primary residence eliminates the income-tax liability if a 1099 is issued.
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Re: Tax implications of foreclosure sale

Postby VinnyZ » Tue Apr 12, 2011 4:30 pm

Judge Roy Bean wrote:Thus, the decision to issue a 1099 is clouded, to say the least. HOWEVER, in the Economic Stabilization Act the exemption of up to $2M of "forgiven" debt on someone's primary residence eliminates the income-tax liability if a 1099 is issued.


I believe that this only applies to "acquisition debt".

The owner is stil going to have some tax issues due to the refi's that were involved.

Based on his/her entire financial situation, the insolvency provisions may still save them from the tax man, however.

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Re: Tax implications of foreclosure sale

Postby ArthurWankspittle » Tue Apr 12, 2011 4:50 pm

Lender is very much alive and kicking, IIRC it is Citibank.
Forgiveness is only allowed on purchase or improvements to the property, I believe. This place has been re-fi'ed and HELOC'ed to death. I doubt if much more than a third of the debt could be said to be purchase and improvements. The owners are a married couple with state jobs. They gross between them about $90k-$100k, so I don't think they can claim insolvency.
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Re: Tax implications of foreclosure sale

Postby Prof » Tue Apr 12, 2011 7:46 pm

ArthurWankspittle wrote:Lender is very much alive and kicking, IIRC it is Citibank.
Forgiveness is only allowed on purchase or improvements to the property, I believe. This place has been re-fi'ed and HELOC'ed to death. I doubt if much more than a third of the debt could be said to be purchase and improvements. The owners are a married couple with state jobs. They gross between them about $90k-$100k, so I don't think they can claim insolvency.


Insolvency here means assets less than liabilities. Gross income will not "count," for, until earned, it is not an asset.

Therefore, the obligation to pay federal (or state) taxes based upon forgiveness of indebtedness treated as income is very questionable, given the gross earnings of the owners.

In my experience, a gross income of 100k -- depending on location -- would not have allowed the accumulation of sufficient assets to matter in a large real estate deficiency case.
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Re: Tax implications of foreclosure sale

Postby ArthurWankspittle » Tue Apr 12, 2011 10:15 pm

OK so assets less than liabilities. But how does that work from a tax point? Let's keep it simple and say sells for $100k, original mortgage $100k, liabilities $300k. They have $200k of debt as far as the lender is concerned, but tax wise? Can they say $300k - $100k repaid - $100k original mortgage = $100k. Tax on $100k ~ $30k-ish? Not nice but affordable on $100k joint income.
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Re: Tax implications of foreclosure sale

Postby Prof » Wed Apr 13, 2011 3:23 pm

ArthurWankspittle wrote:OK so assets less than liabilities. But how does that work from a tax point? Let's keep it simple and say sells for $100k, original mortgage $100k, liabilities $300k. They have $200k of debt as far as the lender is concerned, but tax wise? Can they say $300k - $100k repaid - $100k original mortgage = $100k. Tax on $100k ~ $30k-ish? Not nice but affordable on $100k joint income.


I think you missunderstand. Here, the I assume you are saying that the first lien note holder holds a note worth $100k and the foreclosure would be for $100k, resulting in no deficiency on the first lien. Tax consequences obviously are $0. In addition, the debtors have borrowed another $200k in second, third, etc. That debt will not be paid; you have assumed that a Form 1099 will be issued by each of those lenders and the aggregate debt forgiven will be $200K and aggregate 1099 will be $200k.

Assets = all of note obligors assets (very little is exempt from the IRS, so assume that this includes all of the debtors' assets. This does not include unearned salary. I assume that there are no exempt assets.

So, equity in cars, household goods, chickens, clothes, dogs, cats, savings, checking accounts, etc. = $____X________

Liabilities includes all debt, including any deficiency established at the sale or by state law process.

So, in our hypo, the debt is $200,000 plus cars, credit cards, old tax debt, etc., =$__Y_______

The, compare X and Y to determine if the rules for forgiveness of debt allow or disallow a tax to be imposed.
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Re: Tax implications of foreclosure sale

Postby ArthurWankspittle » Wed Apr 13, 2011 4:19 pm

Prof, the scenario is more like this:
Bought house years ago with mortgage for $100k
Over the years have HELOC'ed, re-fi'ed etc. ending with a remortgage to raise money to spend and clear all the other loans. Let's call this the $300k. As this has been used to repay other secured loans, there aren't any other significant secured debts. So, one big first lien / mortgage for $300k, all they get back at foreclosure is $100k. They are out $200k. Non-judicial foreclosure so they write it off and don't/can't chase the outstanding (? don't know). If they write it off do they issue a 1099C?
Then how does the recipient deal with the 1099C if it is for $200k? Can they claim $100k off it for the original purchase mortgage, or is the $100k the auction raised considered to balance that off? The interpretation and law leaves a tax liability of between $0 and $200k, which is a pretty big spread.
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Re: Tax implications of foreclosure sale

Postby Prof » Wed Apr 13, 2011 5:45 pm

ArthurWankspittle wrote:Prof, the scenario is more like this:
Bought house years ago with mortgage for $100k
Over the years have HELOC'ed, re-fi'ed etc. ending with a remortgage to raise money to spend and clear all the other loans. Let's call this the $300k. As this has been used to repay other secured loans, there aren't any other significant secured debts. So, one big first lien / mortgage for $300k, all they get back at foreclosure is $100k. They are out $200k. Non-judicial foreclosure so they write it off and don't/can't chase the outstanding (? don't know). If they write it off do they issue a 1099C?
Then how does the recipient deal with the 1099C if it is for $200k? Can they claim $100k off it for the original purchase mortgage, or is the $100k the auction raised considered to balance that off? The interpretation and law leaves a tax liability of between $0 and $200k, which is a pretty big spread.


Assume that the lenders who hold the junior positions on the house are out $200k after the foreclosure.

Assume that those lenders hold/can establish deficiencies (in Texas, for example, home equity loans are non-recourse to the borrower). Assume those lenders send out 1099's for a total of $200K.

Compare assets against liabilities. Assume that the only liablity is the $200K.

1. In bankruptcy, the foregiveness indebtedness does not create a taxable obligation; and,
2. IIRC, and I don't have time to check, the $200K forgiveness income counts as a liability, so the debtors would have to have assets in excess of 200K before they have forgivness income; however, the 200K does not just disappear, but would absorb all positive tax attributes of the taxpayers, such as carry-forwards, etc. Check this last bit with someone who deals with this issue daily and/or who has time to review the statute and cases.
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