Who claims forgiven debt in a divorce?

[coda]

What is the name of your state (only U.S. law)? IL

This is complicated. I divorced last year. We have been going through a short sale that has just closed. The Mortgage Forgiveness Act expired, and so we will have to claim the cancelled debt on our taxes. The total taxable amount is roughly $50,000. If a debtor is insolvent at the time the debt is forgiven, it is not taxable. My ex-wife currently has $7,000 in an IRA, but will be offically given $20,000 from my 403b, awarded to her in the divorce finalized last year, next month. My account currently has $60,000, so will drop to $40,000, but this will not happen until after the closing. The agreement is that we each will claim half of the forgiven debt on our returns. However, if she claims all of it, she will not have any tax to pay, as she will be insolvent. Because of my retirement balance, I would not qualify and would have to pay the tax on $25,000. My ex-wife has no interest in helping me, so I don't want to broach the topic of her claiming it all if I don't have to. If I claimed it all, and it was after the $20,000 is transferred from my 403b, I would also be insolvent, and would owe no tax. I have a court order that shows that this money is due to her, but it will still technically be in my account at the time of the close of the short sale. Can I argue that I was insolvent, as the money in my 403b was mine in name only at that point? And can we even decide that all of the forgiven debt can go to one of us, or do we have to, legally, split it as each report half on our returns?

I hope the above makes sense. I appreciate any help you can offer.

 

[LdiJ]

What is the name of your state (only U.S. law)? IL

This is complicated. I divorced last year. We have been going through a short sale that has just closed. The Mortgage Forgiveness Act expired, and so we will have to claim the cancelled debt on our taxes. The total taxable amount is roughly $50,000. If a debtor is insolvent at the time the debt is forgiven, it is not taxable. My ex-wife currently has $7,000 in an IRA, but will be offically given $20,000 from my 403b, awarded to her in the divorce finalized last year, next month. My account currently has $60,000, so will drop to $40,000, but this will not happen until after the closing. The agreement is that we each will claim half of the forgiven debt on our returns. However, if she claims all of it, she will not have any tax to pay, as she will be insolvent. Because of my retirement balance, I would not qualify and would have to pay the tax on $25,000. My ex-wife has no interest in helping me, so I don't want to broach the topic of her claiming it all if I don't have to. If I claimed it all, and it was after the $20,000 is transferred from my 403b, I would also be insolvent, and would owe no tax. I have a court order that shows that this money is due to her, but it will still technically be in my account at the time of the close of the short sale. Can I argue that I was insolvent, as the money in my 403b was mine in name only at that point? And can we even decide that all of the forgiven debt can go to one of us, or do we have to, legally, split it as each report half on our returns?

I hope the above makes sense. I appreciate any help you can offer.

First, the Mortgage Debt Forgiveness Act did expire but there is a bill before Congress to bring it back for 2014 so you should not assume anything at this point. Congress often brings things back retroactively, and this one has bipartisan support.

Second, insolvency works a little different than you think it does. It is calculated based on what your asset and debt situations were, PRIOR to the debt being cancelled.

So, lets say that your house was worth 100k, and you ended up with cancelled debt of 50k because you were underwater on the mortgage. You and your wife had combined assets of 180k (house, retirement funds, cash in the bank, cars, household goods etc.) and 160k (150k mortgage and 10k credit cards) then you are insolvent in the amount of 180k-160k = 20k. Therefore 20k could be excluded from your tax return on an insolvency basis, not the entire cancelled debt of 50k.

Most likely the IRS would expect the cancelled debt to be on the tax return of the primary borrower (the borrower whose SSN is attached to the mortgage and under whose SSN the mortgage interest is normally reported). However, the secondary borrower can also claim the cancelled debt, but generally that will mean that the primary borrower will generally have to prove it, about a year later, when the IRS challenges the fact that the cancelled debt did not appear on their tax return. The same thing would happen if the cancelled debt were split, because the full amount would not appear on the tax return of the party under whose SSN its reported.

I am pretty sure that you would have to calculate your joint insolvency (if you are insolvent) and then divide not only the cancelled debt, but also the amount of the insolvency exclusion that you are claiming.

However again, there is every possibility that the Mortgage Debt Forgiveness Act will come back for 2014. Therefore you should not make any assumptions until its certain that it will not...and that could be as late as December of 2014.

 

[coda]

First, the Mortgage Debt Forgiveness Act did expire but there is a bill before Congress to bring it back for 2014 so you should not assume anything at this point. Congress often brings things back retroactively, and this one has bipartisan support.

Second, insolvency works a little different than you think it does. It is calculated based on what your asset and debt situations were, PRIOR to the debt being cancelled.

So, lets say that your house was worth 100k, and you ended up with cancelled debt of 50k because you were underwater on the mortgage. You and your wife had combined assets of 180k (house, retirement funds, cash in the bank, cars, household goods etc.) and 160k (150k mortgage and 10k credit cards) then you are insolvent in the amount of 180k-160k = 20k. Therefore 20k could be excluded from your tax return on an insolvency basis, not the entire cancelled debt of 50k.

Most likely the IRS would expect the cancelled debt to be on the tax return of the primary borrower (the borrower whose SSN is attached to the mortgage and under whose SSN the mortgage interest is normally reported). However, the secondary borrower can also claim the cancelled debt, but generally that will mean that the primary borrower will generally have to prove it, about a year later, when the IRS challenges the fact that the cancelled debt did not appear on their tax return. The same thing would happen if the cancelled debt were split, because the full amount would not appear on the tax return of the party under whose SSN its reported.

I am pretty sure that you would have to calculate your joint insolvency (if you are insolvent) and then divide not only the cancelled debt, but also the amount of the insolvency exclusion that you are claiming.

However again, there is every possibility that the Mortgage Debt Forgiveness Act will come back for 2014. Therefore you should not make any assumptions until its certain that it will not...and that could be as late as December of 2014.

That was really helpful information, thanks very much. And, believe me, I know all about bills before congress. I google it daily, always with fingers crossed!

Thanks again for the detailed response.

 

[davew128]

The agreement is that we each will claim half of the forgiven debt on our returns. However, if she claims all of it, she will not have any tax to pay, as she will be insolvent.

I just want to point out that this aspect of the divorce agreement is not binding on the IRS and if pressed they would look to whom was responsible legally for paying the debt regardless of the divorce. The Code section governing division of property pursuant to a divorce refers to property, not assumption of debt.

 

[LdiJ]

I just want to point out that this aspect of the divorce agreement is not binding on the IRS and if pressed they would look to whom was responsible legally for paying the debt regardless of the divorce. The Code section governing division of property pursuant to a divorce refers to property, not assumption of debt.

I agree however it appears that they are both on the mortgage and deed so they would both be legally responsible for the debt.