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Mortgage Debt Relief Act Issues/Questions

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dza111

Junior Member
EDIT: The short sale house is in Maryland.

Long story short, we purchases a house in 2006 and converted it to a rental in May of 2013 (because we couldn't afford to sell - underwater). Our interest only mortgage turned to P & I in May of 2016. We have 2 mortgages, from the start. We listed the property as a short sale and it is currently under contract. We thought we were covered under the Mortgage Debt Relief Act.

Now the long story...

Under the spirit of the Act, it should cover those that are under a hardship and not investors, etc. It's my opinion, probably, but we're trying.

We did not live in the property in 2 of the last 5 years. We lived there 1 year and 7 months of the last 5 years. It was rented for 3 years and the property has now been vacant for 5 months.

I purchased the property as my primary residence and only converted it as a rental because we felt we had to. Is there any out at all?

The other issues are that we refinance back in 2007 and took money out to pay off two auto loans.

I read some things on the IRS on reduced maximum exclusion. How can I tell if I qualify for that? The verbiage on that went a little over my head when it talked about unforeseeable circumstances and such. I think the only part that I'm excluded from is the part that talks about the issue arising at the time of the sale. Sadly, the problem is that I didn't know our interest only loan was going to become a P & I after 10 years. So the unforeseeable circumstances should have been seen if my younger self was diligent.

What's the next step? If I continue with the short sale, we look to also have about 31k in capital gains taxes. I'm upside down on the mortgages by 76k. The 1st lender offered the 2nd lender 6k. That means the forgiven debt on the 1st mortgage will be 2k and the forgiven debt on the 2nd mortgage will be 74k.

I looked into insolvency. I don't believe I am, but let me also as this... on the IRS worksheet for insolvency, it has me list retirement "interest". What does that mean? Do I only have to list the interest gained in my retirement fund and count that against my total debt? If so, how do I figure that out? The majority of my retirement fund is employee owned stocks and the company sold. Of course the cash value before the sale was invested. If I look at my retirement balance, I'm not insolvent. If that was out of the equation, I definitely am. Thoughts?

If I proceed with the short sale, I don't think I qualify for an offer in compromise. I believe my only option would be an installment plan but I'd be looking at about way too much a month.

If I end the contract, do we know if the purchaser, realtor or anyone can sue me? I went in thinking I'd owe the IRS a few bucks, not 50k.

Thank you for the help. It seems like I keep finding possible options that I barely don't qualify for or a IRS law that I have no idea about. I've talked to a CPA that recommended a Tax Attorney. I spoke with a Tax Attorney and they recommended keeping the property as a rental (even though I'm taking a loss each month now. However, I need to find out for sure how much I will be obligated to pay the IRS. Also, the Attorney mentioned that it'd be my responsibility to report cancellation of debt as income regardless of the banks sending 1099-c or not. I'm officially waiting on the approval letter from the bank so I have no idea if they'll send a 1099 (in case someone asks).

-D
 
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LdiJ

Senior Member
EDIT: The short sale house is in Maryland.

Long story short, we purchases a house in 2006 and converted it to a rental in May of 2013 (because we couldn't afford to sell - underwater). Our interest only mortgage turned to P & I in May of 2016. We have 2 mortgages, from the start. We listed the property as a short sale and it is currently under contract. We thought we were covered under the Mortgage Debt Relief Act.

Now the long story...

Under the spirit of the Act, it should cover those that are under a hardship and not investors, etc. It's my opinion, probably, but we're trying.

We did not live in the property in 2 of the last 5 years. We lived there 1 year and 7 months of the last 5 years. It was rented for 3 years and the property has now been vacant for 5 months.

I purchased the property as my primary residence and only converted it as a rental because we felt we had to. Is there any out at all?

The other issues are that we refinance back in 2007 and took money out to pay off two auto loans.

I read some things on the IRS on reduced maximum exclusion. How can I tell if I qualify for that? The verbiage on that went a little over my head when it talked about unforeseeable circumstances and such. I think the only part that I'm excluded from is the part that talks about the issue arising at the time of the sale. Sadly, the problem is that I didn't know our interest only loan was going to become a P & I after 10 years. So the unforeseeable circumstances should have been seen if my younger self was diligent.

What's the next step? If I continue with the short sale, we look to also have about 31k in capital gains taxes. I'm upside down on the mortgages by 76k. The 1st lender offered the 2nd lender 6k. That means the forgiven debt on the 1st mortgage will be 2k and the forgiven debt on the 2nd mortgage will be 74k.

I looked into insolvency. I don't believe I am, but let me also as this... on the IRS worksheet for insolvency, it has me list retirement "interest". What does that mean? Do I only have to list the interest gained in my retirement fund and count that against my total debt? If so, how do I figure that out? The majority of my retirement fund is employee owned stocks and the company sold. Of course the cash value before the sale was invested. If I look at my retirement balance, I'm not insolvent. If that was out of the equation, I definitely am. Thoughts?

If I proceed with the short sale, I don't think I qualify for an offer in compromise. I believe my only option would be an installment plan but I'd be looking at about way too much a month.

If I end the contract, do we know if the purchaser, realtor or anyone can sue me? I went in thinking I'd owe the IRS a few bucks, not 50k.

Thank you for the help. It seems like I keep finding possible options that I barely don't qualify for or a IRS law that I have no idea about. I've talked to a CPA that recommended a Tax Attorney. I spoke with a Tax Attorney and they recommended keeping the property as a rental (even though I'm taking a loss each month now. However, I need to find out for sure how much I will be obligated to pay the IRS. Also, the Attorney mentioned that it'd be my responsibility to report cancellation of debt as income regardless of the banks sending 1099-c or not. I'm officially waiting on the approval letter from the bank so I have no idea if they'll send a 1099 (in case someone asks).

-D
I think that it would probably be a good idea if you got a consult with a completely different tax professional than the CPA that you previously spoke to. You definitely do NOT need a tax attorney at this point. You are no where near the point yet where you need a tax attorney. What you need is someone who can take your actual numbers and help spell out for you what you are going to really owe in tax. Look for a local tax office that is open year round.

You have three issues to deal with. 1) Calculating capital gain and tax on that. 2) Calculating depreciation recapture and tax on that. 3) Calculating cancelation of debt income and tax on that. In order for the tax professional to best assist you, they will need to see your last year's tax return, information on your current income unless it is going to be similar to last year, they will need to know what you purchased the home for and the cost of any major improvements you made, and they will need to know what you are selling the home for and what your selling expenses will be. You will also need to tell them that the cancelled debt is going to be about 76k.

They can also help you determine whether or not insolvency actually applies to you. If you do a net worth statement (google that, you will find all kinds of examples online) that would be helpful to provide the tax professional.

I am guessing that you are calculating the capital gains tax totally wrong, but that is only a guess since I do not have any of your numbers.
 

LdiJ

Senior Member
Here is an example of a capital gains calculation:

You originally paid 250k for the house. You put a new roof on it for 15k. Your total basis is 265k

You are selling the house for 300k. Your selling expenses (realtor's fees and closing costs) will be about 30k. Your net sales prices is 270k.

270k - 265k = 5k in capital gain. Capital gains tax is 15% of the 5k or $750.00.

You would have to have over 200k in capital gain to have capital gains taxes of 31k. If that was the case, I think it would be highly unlikely that you would have any need for a short sale.
 

dza111

Junior Member
Interesting.

Re: Capital gains.
Did not know that and my CPA did not either. Its the lesser of purchase price and FMV, right? On my tax returns, I went with a FMV of 149 and the sale price is 180. 15% of 31 is all I am responsible for? 4650 is high but not as high as 31k as income. I did not mean that I would owe 31k, but that I thought I would be taxes as 31k as income (so 28% or whatever). Also, for FMV, I went with tax assest value bc the comp analysis was rather similar at the time.

Re: the rest
I am tracking down another CPA and will look up my net worth. To be clear on my numbers. I owe 256 and the contracted sale price is 180. Thats where the 76k in COD comes from. Assuming Im not insolvent, would I be paying income taxes on the 76k? So, my tax bracket rate * 76k added to my taxes (less deductions etc)? That is still a big number and I believe MD's rate is another 8%.
 

dza111

Junior Member
And yea, I am not insolvent according to net worth calcs. Retirement funds are doing me no favors right now.
 

LdiJ

Senior Member
Interesting.

Re: Capital gains.
Did not know that and my CPA did not either. Its the lesser of purchase price and FMV, right? On my tax returns, I went with a FMV of 149 and the sale price is 180. 15% of 31 is all I am responsible for? 4650 is high but not as high as 31k as income. I did not mean that I would owe 31k, but that I thought I would be taxes as 31k as income (so 28% or whatever). Also, for FMV, I went with tax assest value bc the comp analysis was rather similar at the time.
No, that is wrong. It is the difference between the basis and the net selling price. FMV has nothing to do with it, although if you can sell for 180k, then 180k would be FMV.

Re: the rest
I am tracking down another CPA and will look up my net worth. To be clear on my numbers. I owe 256 and the contracted sale price is 180. Thats where the 76k in COD comes from. Assuming Im not insolvent, would I be paying income taxes on the 76k? So, my tax bracket rate * 76k added to my taxes (less deductions etc)? That is still a big number and I believe MD's rate is another 8%.
You are leaving out a key, critical figure, and that is what you originally paid for the home plus major improvements (your basis). I am not going to comment further until you provide that number.
 

dza111

Junior Member
I paid 221,000, and replaced the roof for 3000 and floors for 5000. I am not sure if those count since the needed to be replaced. Let's call it 229,000. However, if a property is a primary residence and converted to a rental, isnt the new cost basis the depreciated value at the time of the conversion? The kicker being that I put a cost basis of 149,000 on my income taxes, not the cost basis of 229,000. So if I truly am selling at a loss (which of course I am bc 180 is less than 229), I would need to resolve the cost basis issue on prior returns, right? Maybe I am misunderstanding the cost basis calculation when I read something like the lesser of purchase price and FMV (at the time of the conversion).
 

LdiJ

Senior Member
I paid 221,000, and replaced the roof for 3000 and floors for 5000. I am not sure if those count since the needed to be replaced. Let's call it 229,000. However, if a property is a primary residence and converted to a rental, isnt the new cost basis the depreciated value at the time of the conversion? The kicker being that I put a cost basis of 149,000 on my income taxes, not the cost basis of 229,000. So if I truly am selling at a loss (which of course I am bc 180 is less than 229), I would need to resolve the cost basis issue on prior returns, right? Maybe I am misunderstanding the cost basis calculation when I read something like the lesser of purchase price and FMV (at the time of the conversion).
No, that is completely wrong. Please go to a tax professional to do your taxes for this year. You do not understand what you are doing at all.

If you have been renting the home for 3-4 years, then you would have had depreciation of no more than about 32k.

You actually have a capital loss 229k-180k = negative 49 minus at least 10k in selling expense, leaving you with somewhere around a 60k capital loss. Even recapturing the depreciation still leaves you with a capital loss of around 28k. So you will not be paying any capital gains tax at all.

I have absolutely no idea how you came up with a cost basis of 149k. However, you need to amend those returns to correct the cost basis. Please get professional help with this so that you do not make any more mistakes.
 

dza111

Junior Member
That is why I am here, I know I did things wrong. I am finding a new CPA. Will the capital loss help offset the 76k of COD significantly? Of course I will be consulting with the CPA. Im receiving pressure from the realtor, and need to tell them if I am still selling... So I am curious what to expect. Thank you.
 

LdiJ

Senior Member
That is why I am here, I know I did things wrong. I am finding a new CPA. Will the capital loss help offset the 76k of COD significantly? Of course I will be consulting with the CPA. Im receiving pressure from the realtor, and need to tell them if I am still selling... So I am curious what to expect. Thank you.

No, the capital loss will not significantly offset the 76k. Capital losses can be taken against capital gains, but if there are no capital gains they can only be taken in the amount of 3000.00 per year until they are used up. So, if you have no other capital gains to be offset by the losses, you will be deducting 3000.00 per year for the next 10 years or so.

You would be crazy not to go ahead and sell. You do not have a renter and haven't had one for 5 months, so all that is happening is that the house is costing you money. If you end up being foreclosed upon the COD income is going to end up massively higher. Just get it sold and be done with it. Once you find out exactly what your tax bite is, then you can set up installment payments with the IRS and Maryland.

Also, do not assume that you are using the net worth stuff to correctly determine whether or not you are insolvent. You have already misunderstood quite a few things, its possible you are misunderstanding those as well. Let a professional help you determine if you are insolvent.

Also, please understand that many CPAs are not all that familiar with individual taxation. Many of them specialize in other areas of accounting or in corporation tax. You need an experienced tax professional, whether they have a CPA designation or an EA designation or whether they are just registered tax preparers. Those tax offices that are open year round tend to have the most experienced people.
 

dza111

Junior Member
I dont have a renter bc my realtor advised against it bc the short sale process was moving along quickly. Was.

Assuming I am paying most of the COD as income (and we will have a pro figure it out), paying income taxes on 76k over 6 years to the IRS is about 300/mo. If we rented, we would lose about 250/mo and be able to offset some at tax time. And we would eventually make money. I dont think its as cut and dry as crazy not to sell. It would be easier to swallow once the capital gain/loss issue is resolved for sure though. My first CPA said we were facing paying 50k in taxes. That is why we are getting a new CPA. One says this, one says that so we are left picking. At 50k, we would be paying 700/mo in taxes. Itd be crazy to sell if thats the case.
 

LdiJ

Senior Member
I dont have a renter bc my realtor advised against it bc the short sale process was moving along quickly. Was.

Assuming I am paying most of the COD as income (and we will have a pro figure it out), paying income taxes on 76k over 6 years to the IRS is about 300/mo. If we rented, we would lose about 250/mo and be able to offset some at tax time. And we would eventually make money. I dont think its as cut and dry as crazy not to sell. It would be easier to swallow once the capital gain/loss issue is resolved for sure though. My first CPA said we were facing paying 50k in taxes. That is why we are getting a new CPA. One says this, one says that so we are left picking. At 50k, we would be paying 700/mo in taxes. Itd be crazy to sell if thats the case.
You are definitely not going to be at 50k. You have no capital gains and the tax on the COD income will not be that high. Between federal and state tax I think that you are going to be well under 30k, and maybe even closer to 25k. Please understand that if you cannot pay the mortgage, and you get foreclosed upon, your COD income will be much higher. If you can easily afford to pay the mortgage, then that might be a different story.
 

dza111

Junior Member
That all depends on if I can find and keep tenants as great as the last ones hah. I cannot carry both houses without a tenant in one.
 

LdiJ

Senior Member
That all depends on if I can find and keep tenants as great as the last ones hah. I cannot carry both houses without a tenant in one.
Ok, then you need to make a decision. Just realize that if you get foreclosed upon your COD income will be much higher therefore the tax will be much higher.
 

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