PMI on foreclosure

[Bill Tubbs]

Client owes $133,000 on house, paid $135,000 a few years ago, and estimates house's FMV at $110,000 (similar house in neighborhood has been sitting unsold at $115,000 for several months). He is behind about 6 months in payments and is thinking of walking away and letting the bank foreclose. (His lawyer is encouraging him to "let it go".)

Does the fact that he has been paying PMI have any bearing on this? I don't think the existence of PMI or not makes any differences on the treatment as Pub 4681 makes no mention of PMI. So, whether or not there is PMI on the mortgage, my understanding is that he would not have any reportable profit on the foreclouse (as long as the bank would sell it for less than $135,000), and would potentially have $23,000 of cancelled debt (if FMV of house is $110,000) reported on 1099-C -- but the $23,000 of cancelled debt would qualify as "Qualified Principal Residence Exclusion" on Form 982, so no effect on their tax return. Does this all sound right?

Also, as long as he stays in the house until he's foreclosed on, he would only receive a 1099-C and no 1099-A -- right?

Bill

[JG EA]

Client owes $133,000 on house, paid $135,000 a few years ago, and estimates house's FMV at $110,000 (similar house in neighborhood has been sitting unsold at $115,000 for several months). He is behind about 6 months in payments and is thinking of walking away and letting the bank foreclose. (His lawyer is encouraging him to "let it go".)

Does the fact that he has been paying PMI have any bearing on this? I don't think the existence of PMI or not makes any differences on the treatment as Pub 4681 makes no mention of PMI. So, whether or not there is PMI on the mortgage, my understanding is that he would not have any reportable profit on the foreclouse (as long as the bank would sell it for less than $135,000), and would potentially have $23,000 of cancelled debt (if FMV of house is $110,000) reported on 1099-C -- but the $23,000 of cancelled debt would qualify as "Qualified Principal Residence Exclusion" on Form 982, so no effect on their tax return. Does this all sound right?

Also, as long as he stays in the house until he's foreclosed on, he would only receive a 1099-C and no 1099-A -- right?

Bill

What Is PMI?

PMI is extra insurance that lenders require from most homebuyers who obtain loans that are more than 80 percent of their new home's value. In other words, buyers with less than a 20 percent down payment are normally required to pay PMI.

Benefits of PMI

PMI plays an important role in the mortgage industry by protecting a lender against loss if a borrower defaults on a loan and by enabling borrowers with less cash to have greater access to homeownership. With this type of insurance, it is possible for you to buy a home with as little as a 3 percent to 5 percent down payment. This means that you can buy a home sooner without waiting years to accumulate a large down payment.

So I think that PMI is for the benefit of the lender not the borrower.

Yes, No sale gain as you said. And Qualified Principal Residence Exclusion on Form 982 works for principal residence - keeping in mind that if there was any refinancing closing costs, equity loans, etc. those parts would not work under this exclusion.

Check out these instructions as to the coordination of 1099A and 1099C forms.

http://www.irs.gov/pub/irs-pdf/i1099ac.pdf

I don't think it means they send it only if abandoned, but rather they can sent A if they acquire it. But they can just send 1099C if it all happens in the same year.

[Bill Tubbs]

Thanks JG.

Thanks for confirming my understanding. It's always great to bounce something new off a colleague before giving new advice to a client.

Bill