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Another informative
article courtesy of the Crews Hahn & Bentrup…
Your ultimate source for Island Real Estate information.
SOME IRS BALM FOR SHORT SALES OF HOMES
by: Julian Block
Congress continues to make changes in the tax code in response to
the housing crisis. A key change helps millions of home sellers who
owe more on their mortgages than their dwellings are worth. These
sellers have negative equity — a condition known colloquially as
being upside down or underwater. Legislation that went on the books
at the start of 2007 significantly benefits some upside downers and
does absolutely nothing for others.
This is how the break works. Suppose Sela Sellers disposes of her
residence in a lender-okayed short sale that erases the unpaid part
of her mortgage. Or suppose the lending company forecloses on the
dwelling, subsequently sells it and cancels a portion of her debt.
Generally, the tax code calls for Sela to report partially or
entirely forgiven amounts on her 1040 form. Not any more. The
Mortgage Forgiveness Debt Relief Act of 2007 includes a provision
that allows homesellers like Sela to exclude as much as $2,000,000
of canceled debt.
Sela excludes (sidesteps) taxes only if she satisfies two
stipulations. First, the security for her mortgage is her principal
residence, meaning the place she ordinarily lives most of the year.
Second, she incurs the debt to buy, build or substantially improve
her principal residence. There is no relief for Sela’s home equity
loans or cash-out refinancings, except to the extent that she uses
the proceeds to make improvements. Other fine print prohibits relief
if her lenders forgive debts on vacation homes and other second
homes or rental properties.
Long-standing rules generally require debtors to report all
forgiven debts on their 1040 forms, just the same as income from
salaries or investments. The Internal Revenue Service taxes forgiven
amounts at the rates for ordinary income from sources like salaries.
Some forgiven debts sidestep taxes. The law specifies several
carefully hedged exceptions. They include bankruptcies and
insolvencies.
The exception introduced in 2007 benefits people whose debts are
reduced or cancelled in arrangements that are known as loan
modifications, foreclosures, deeds in lieu of foreclosure and short
sales. This last category is the term for an owner who — with lender
approval — sells for a net sales price (gross sales price minus
legal fees, broker’s commission and other costs) that is
insufficient to cover all of the outstanding debt.
In tax lingo, the exclusion is for income from the discharge of
QPRI, short for qualified principal residence indebtedness. This
means mortgages taken out by owners to buy, build, or substantially
improve their principal residences. And the residences are the
securities for the debts.
There also is an exclusion for debt reduced through mortgage
restructuring, as well as for debt used to refinance QPRI. Here,
there is relief, but only up to the amount of the old mortgage
principal, just before the refinancing.
Another constraint is that the exclusion does not help homeowners
who took advantage of the run up in real estate prices to do
“cash-out” refinancing, in which they did not use the funds for
renovations of their primary residences. Instead, they used the
funds to pay off credit card debts, tuition charges, medical
expenses, or certain other expenditures.
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Julian Block is an attorney and author based in Larchmont, N.Y. He
has been cited as "a leading tax professional" (New York Times), "an
accomplished writer on taxes" (Wall Street Journal) and "an
authority on tax planning" (Financial Planning Magazine). This
article is excerpted from “The Home Seller’s Guide To Tax Savings.”
Law professor James Edward Maule of Villanova University praised the
book as “An easy-to-read and well-organized explanation of the tax
rules. Home sellers would be well advised to buy this book.” To
order it, go to
www.julianblocktaxexpert.com. © 2010, Julian Block, All Rights
Reserved.
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