The housng crss may have dropped from the headlnes n rect months.  Unfortunately, however, the crss remans a realty – a pottally taxable realty – for mllons of Amercan homeowners. 

Accordng to a study by Realty Trac, 17% of resdtal propertes n the Unted States wth a mortg remaned “serously underwater” (also called negatve equty) as of March 31, 2014.  To be consdered serously underwater the mortg amount(s) on a property must be at least 25% hgher than the property’s currt far market value. 

Local underwater statstcs also contnue to reman much hgher than the natonal aver.  Accordng to Zillow’s negative equity map (whch ranks owner equty by zp code and s avalable at Zllow.com), approxmately 27% of mortgd n the Martnsburg and Charles Town areas remaned underwater as of the June 30, 2014.  These dscouragng statstcs place much of the regon among the 10% of zp codes n the Unted States expercng the hghest negatve-equty rates as a perct of mortgd

What does ths mean for those underwater? Although housng prces have ncreased n rect years, t remans hghly probable that those who purchased or refnanced (1) a home, (2) a second home, or (3) a rtal/nmt/busness property betwe 2003 and 2007 stll owe more on that property than t s .  Those n ths unfortunate poston face one of three choces f they choose to leave the property: 

A “short sale” occurs wh the mortg holder allows the property owner to sell at a prce less than the balance owed on the mortgAbandonmt occurs wh the owner leaves the property and the mortge takes possesson.  Gerally, the property s foreclosed upon later.  Foreclosures (and Deeds n Leu) occur wh the mortge takes ttle to a property.

Owners who attempt to short sell ther have three more choces to consder regardng ther mortg(s):

For many debtors, partcularly those havng a dffcult makng ther currt mortg paymts, payng off the loan balance or refnancng the balance wth another debt wll prove fnancally unrealstc.  As a result, many owners ask the lder to cancel the remanng debt. 

Be Aware: f the lder cancels the debt – whether the result of short sale, abandonmt or foreclosure – the property owner may owe ncome tax on the debt that s cancelled.

Taxable Consequces:  Wh a property s sold short, abandoned, or foreclosed upon, and debt s cancelled, two pottally taxable evts occur. 

Calculatng Captal Gan/Loss:  n order to calculate the taxable gan or loss from a short sale or foreclosure, the property’s sales prce must be determned. 

To Calculate Captal Gan or Loss: Once “sales prce” s determned, the captal gan or loss s calculated by subtractng the owner’s nmt, called “bass,” from the sales prce.  Gerally, the owner’s bass represts the owner’s nmt n the property.  Ths ncludes (but s not lmted to) orgnal purchase prce plus captal mprovemts (such as addtons and extsve remodelng).  f the dfferce betwe sales prce and bass s postve, there s captal gan; f negatve, a captal loss. 

t may be helpful to keep the followng ponts n mnd regardng ths gan or loss:

Cancellaton of Debt ncome (COD): Cancellaton of debt ncome can occur wh the amount of recourse debt exceeds the property’s far market value (or sales prce f the property s sold) and the lder forgves the remanng debt.  Note: Ths cancelled debt wll consttute taxable ncome unless one or more apples.  These exclusons nclude (but are not lmted to):

The Bankruptcy excluson s farly straght forward but the debt must be dscharged n the bankruptcy – before t s cancelled.  Provng nsolvcy, however, requres addtonal calculatons to determne whether the debtor had a negatve net just pror to the debt cancellaton.  The Qualfed Farm Debt Excluson requres the property owner to have earned the majorty of ther ncome from for the prevous three years and the debt to be drectly related to the busness of

The Qualfed Real Busness Property and Qualfed Prncple Resdce ndebtedness Excluson apply only to “qualfed acquston debt:” (ncludng refnanced acquston debt).  Acquston debt s debt used to acqure, construct or substantally mprove the property.  Any debt forgv that s not qualfed acquston debt wll be taxable unless another exempton apples.

Note: As of the of ths wrtng, although legslaton has be ntroduced to extd the Qualfed Prncpal Resdce ndebtedness Excluson, t has NOT be extded to nclude debt forgv n 2014.

CAUTON: Warnng and Take Away –The taxaton and canceled debt exclusons related to the sale or loss of an under-water property are hghly complex and also oft requre what s called “Reducton of Tax Attrbutes.”  Ths or any artcle can only scratch the surface. f you should fnd yourself facng the sale or loss of an underwater-property please seek tax advce before movng forward.  As always, ths artcle s for nformatonal purposes only and does not consttute tax advce.  f we can be of any assstance wth ths or any tax or busness ssue, please feel to contact our offce at (304) 267-2594. 

 

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