Mortgage Forgiveness Debt Act Scenario

[wiesemc]

Hello,

Live in Nevada. Purchased home in 2005 and bought another home in 2009. The 2005 home became my rental property in 2009. About to short sale the 2005 home and was wondering if there's any recourse from Uncle Sam where I would owe money from the 1099c? The 2005 home wasn't initially purchased as an investment/rental property. Would appreciate any help on to what to expect. Thank you very much.

 

[FlyingRon]

While there seems to be some controversy on this subject, my read of the regulation is that if the loan was taken out to acquire or improve what was your personal residence at the time, it qualifies for the exclusion. The fact that it was subsequently converted to rental doesn't matter. Note that the forgiveness doesn't go away, it just gets rolled into the basis of the property so you are taxed with it as a capital gain. Of course, you probably still don't have much of a gain if you're short selling it, and it appears you meet the 24/60 test for excluding any of that gain anyway.

 

[LdiJ]

While there seems to be some controversy on this subject, my read of the regulation is that if the loan was taken out to acquire or improve what was your personal residence at the time, it qualifies for the exclusion. The fact that it was subsequently converted to rental doesn't matter. Note that the forgiveness doesn't go away, it just gets rolled into the basis of the property so you are taxed with it as a capital gain. Of course, you probably still don't have much of a gain if you're short selling it, and it appears you meet the 24/60 test for excluding any of that gain anyway.

I see it that way as well, but I have to state that there is again, considerable controversy on the subject and many well respected tax professionals feel strongly that unless the property was your personal residence at the time of the short sale, or within a few months of the short sale, that the cancelation of debt does not qualify for the exclusion.

They would state that your conversion of the property to a rental property disqualifies it from the exclusion.

 

[wiesemc]

Thank you FlyingRon and LdiJ for your comments. It's always difficult to find those in the same situation then we'd know for sure. Appreciate giving me some confidence that I'll be able to survive the 2011 tax season.

 

[wiesemc]

I called the IRS. Was told that my 2005 property would be considered an investment one. Didn't matter that it was purchased initially as a primary residence and that it was only rented for about six months. I will though qualify as insolvent I was told based on my current situation. Lucky me...I guess.

 

[FlyingRon]

And more specifically, you can't use the information they give you as the basis for any sort of defense in an audit. At least a real tax professional may warrant their work and pay the resulting penalty from giving their opinion of the code.

 

[LdiJ]

I called the IRS. Was told that my 2005 property would be considered an investment one. Didn't matter that it was purchased initially as a primary residence and that it was only rented for about six months. I will though qualify as insolvent I was told based on my current situation. Lucky me...I guess.

There are actually two issues that you will deal with if the property is treated as an investment property.

You will first have to deal with the sale of the property on Schedule D. That may or may not result in a capital gain or loss, depending on your amount of basis in the home (original purchase price plus cost of improvements) vs the net selling price (actual sales price minus selling costs).

Then you would also have the opportunity to exclude any of the cancellation of debt income to the extent that you can prove insolvency.

I definitely recommend that you use a tax professional for 2011. Don't try to do this one on your own, and don't necessarily use one of the national tax preparation chains either. Make sure that whoever you use is familiar with sales of investment property and cancellation of debt.

 

[FlyingRon]

You will first have to deal with the sale of the property on Schedule D. That may or may not result in a capital gain or loss, depending on your amount of basis in the home (original purchase price plus cost of improvements) vs the net selling price (actual sales price minus selling costs).

Don't forget depreciation! That's enough of a headache (especially if he hasn't been taking it) to send me to a tax professional right there.

Fortunately, it looks like (as I stated a few posts back) eligible for exclusion of the gain. He still has to wrap his head around the depreciation issues.

 

[davew128]

Don't forget depreciation! That's enough of a headache (especially if he hasn't been taking it) to send me to a tax professional right there.

If the six months of rental use occured in the year the rental use began, there is no depreciation.

 

[FlyingRon]

If the six months of rental use occured in the year the rental use began, there is no depreciation.

Eh? He converted it to rental use in 2009. He's got all of 2010 to worry about. It's only one year, but still it's not the most casual of calculations to do after the fact.

 

[davew128]

Eh? He converted it to rental use in 2009. He's got all of 2010 to worry about. It's only one year, but still it's not the most casual of calculations to do after the fact.

Didn't matter that it was purchased initially as a primary residence and that it was only rented for about six months.

Wanna try that again?

 

[FlyingRon]

Wanna try that again?

Ooops, I missed that.