The slumping housing market is s.  If you purched or refinanced a home, a second home, or ral/investm/business property from 2002 to 2008, you probably owe more on that property than it is worth – referred to “upside down.”  If you’re in this situation you are alone.  Nationwide 23% of homeowners find themselves owing more on their home(s) than their home(s) is worth.  In some regions, such many are in Nevada, upw of 6% of homeowners are finding themselves “upside down” in their mortgages.

Definitions and Consequences:  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.  Abandonm occurs when the owner leaves the property and the mortgagee takes possession.  Generally, the property is foreclosed upon later. Foreclosures occur when the mortgagee takes legal title to a property. 

When a property is sold short, abandoned, or foreclosed upon, two potially taxable evs occur. 

First, a “sale” h occurred.  A property that is sold short is sold in a normal sales transaction although the sales price is less than the amount owed on the mortgage.  When a property is abandoned or foreclosed upon there is no contractual sale but the property is, in effect, sold to its creditors.  These “sales” may result in taxable capital gain or deductible loss (e that losses on personal-use property, such a residence, are tax deductible). 

Second, short sales and foreclosures may also result in taxable if any portion of the mortgage is forgen (unless a specific exception lies).  This is called Cancellation of Debt .

Calculating Capital Gain/Loss:  In order to calculate the taxable gain or loss from a short sale or foreclosure, the property’s sales price must be determined.  For a short sale this is relately ey.  The sales price is the contract price.  Determining the sales price of a foreclosed property is a bit more complex.  The “sales price” of a foreclosure will depend on whether the property’s mortgage is “recourse” or “nonrecourse.”  Recourse loans are loans the borrower remains personally liable for after foreclosure.  Nearly all mortgages in WV, VA, MD and PA are recourse mortgages.  For recourse loans, the “sales price” is the lesser of the loan amount or the fair market value of the property. 

Once “sales price” is determined, the capital gain or loss is calculated by subtracting the owner’s investm, called “bis,” from the sales price.  Generally, the owner’s bis includes (but is limited to) original purche price plus capital improvems (such additions, etc.).  If the difference between sales price and bis is posite, there is capital gain; if negate, a capital loss.  If there is a capital gain and the owner led in the property their primary residence for two of the pt fe years, he may be able to exclude all or a portion of the gain from .  A capital loss on business or investm property may be deductible.  Losses on personal-use property, however, are tax deductible.

Cancellation of Debt (CODI): Cancellation of debt can occur when the amount of recourse debt exceeds the property’s fair market value (or sales price if the property is sold) and the bank forges the remaining debt.  This cancelled debt will be taxed ordinary unless an exemption lies.  These exemptions include (but are limited to):

The Bankruptcy exclusion is fairly straight forward and must occur before the debt is cancelled.  Proving insolvency, however, requires additional calculations.  The qualified real business property and principle residence debt lies only to “qualified acquisition debt:” debt (including refinanced debt) used to acquire, construct or substantially improve the property.  Any debt forgen that is qualified acquisition debt will be taxable unless aher exemption lies.

This brochure provides bic information regarding the tax consequences of short-sale, abandonm, and/or foreclosure.  These complex issues may require the sistance of a qualified tax professional to minimize tax liability.  If you need sistance, we would be honored by the opportunity to sist you.  Plee be sure to contact our office before you face a short sale, abandonm, or foreclosure.

Further Reading

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