The housing isis may have dropped from the headlines in recent months.  Unfortunately, however, the isis remains a reality – a potentially tax reality – for millions of Amerin homeowners. 

According to a study by Realty Trac, 17% of residential properties in the United States with a mortgage remained “seriously underwater” (also lled negative equity) as of March 31, 2014.  To be considered seriously underwater the mortgage amount(s) on a property must be at least 25% higher than the property’s current fair market value. 

Lol underwater statistics also continue to remain much higher than the national average.  According to Zillow’s negative equity map (which ranks owner equity by zip code and is avail at Zillow.com), approximately % of mortgaged homes in the Martinsburg and Charles Town areas remained underwater as of the June 30, 2014.  These discourng statistics place much of the region among the 10% of zip codes in the United States experiencing the highest negative-equity rates as a percentage of mortgaged homes. 

What does this mean for those underwater? Although housing prices have ineased in recent years, it remains highly prob that those who purchased or red (1) a home, (2) a second home, or (3) a rental/investment/ property between 2003 and 2007 still owe more on that property than it is worth.  Those in this unfortunate position face one of three choices if they choose to leave the property: 

A “short sale” occurs when the mortgage holder allows the property owner to sell at a price less than the balance owed on the mortgage.  Aonment occurs when the owner leaves the property and the mortgagee takes possession.  Generally, the property is foreclosed upon later.  Foreclosures (and Deeds in Lieu) occur when the mortgagee takes legal title to a property.

Owners who attempt to short sell their homes have three more choices to consider regarding their mortgage(s):

For many debtors, particularly those having a difficult time making their current mortgage payments, paying off the balance or refinancing the balance with another debt will prove financially unrealistic.  As a result, many owners ask the lender to ncel the remaining debt. 

Be Aware: If the lender ncels the debt – whether the result of short sale, aonment or foreclosure – the property owner may owe income tax on the debt that is ncelled.

Tax Consequences:  When a property is sold short, aoned, or foreclosed upon, and debt is ncelled, two potentially tax events occur. 

lculating pital Gain/Loss:  In order to lculate the tax gain or loss from a short sale or foreclosure, the property’s sales price must be determined. 

To lculate pital Gain or Loss: Once “sales price” is determined, the pital gain or loss is lculated by subtracting the owner’s investment, lled “basis,” from the sales price.  Generally, the owner’s basis represents the owner’s investment in the property.  This includes (but is not limited to) original purchase price plus pital improvements (such as additions and extensive remodeling).  If the difference between sales price and basis is positive, there is pital gain; if negative, a pital loss. 

It may be helpful to keep the following points in mind regarding this gain or loss:

ncellation of Debt Income (CODI): ncellation of debt income n occur when the amount of recourse debt exceeds the property’s fair market value (or sales price if the property is sold) and the lender forgives the remaining debt.  Note: This ncelled debt will constitute tax income unless one or more applies.  These exclusions include (but are not limited to):

The Bankruptcy exclusion is fairly straight forward but the debt must be discharged in the bankruptcy – before it is ncelled.  Proving insolvency, however, requires additional lculations to determine whether the debtor had a negative net worth just prior to the debt ncellation.  The Qualified Farm Debt Exclusion requires the property owner to have earned the majority of their income from farming for the previous three years and the debt to be directly related to the of farming. 

The Qualified Real Property and Qualified Principle Residence Indebtedness Exclusion apply only to “qualified acquisition debt:” (including red acquisition debt).  Acquisition debt is debt used to acquire, construct or substantially improve the property.  Any debt forgiven that is not qualified acquisition debt will be tax unless another exemption applies.

Note: As of the time of this writing, although legislation has been introduced to extend the Qualified Principal Residence Indebtedness Exclusion, it has NOT been extended to include debt forgiven in 2014.

UTION: and Take Away –The taxation and nceled debt exclusions related to the sale or loss of an under-water property are highly complex and also often require what is lled “Reduction of Tax Attributes.”  This or any article n only satch the surface. If you should find yourself facing the sale or loss of an underwater-property please seek tax advice before moving forward.  As always, this article is for informational purposes only and does not constitute tax advice.  If we n be of any assistance with this or any tax or issue, please feel to contact our office at (304) 267-2594. 

 

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