Residence Sale - Gain

[Snaggletooth]

The best way to ask this is to create an example:

Joseph paid $100,000 for his personal residence. Over the years the value increased, and a second mortgage was taken out for $40,000.

In 2007 housing values crashed and Joseph lost his job. In 2009, Bank holding the first mortgage foreclosed and sold home for $98,000. First mortgagee was satisfied, but second mortgagee was left holding the bag. Joseph has a $2000 capital loss, nondeductible.

Upon sale, the second mortgage company issued Joseph a 1099-C for $35,000. Section 14 of TTB says that the $35,000 is exempt because of being a personal residence, however, the amount of forgiven debt must be SUBTRACTED from Joseph's basis.

This converts Joseph's basis from $100,000 to only $65,000. And the $2000 loss is converted to a $33,000 GAIN.

Normally gain on the sale of a personal residence is exempt up to statutory limits. However, there is $33,000 gain created because of the forgiven debt. Is this gain still exempt by virtue of Sec. 121?

[Lion]

Yes?

My first inclination would be that gain created that way would be eligible for exclusion, so I would start researching Sec 121 and its legal outgrowths to find a similar fact set.

[Gretel]

Ron, you have two transactions. One is the sale of the home for which Sec. 121 applies, the second is debt forgiveness. If memory serves right, there is a special exclusion for home owners but only for acquisition debt.

I probably can dig up some more info if needed.

[Bill Tubbs]

home owner exclusion

Snags,

I agree with Gretel -- the special exclusion for home owners only applies to acquisition debt. So, the 2nd mortgage would only qualify for the exclusion if it was to improve the home.

Bill

[Snaggletooth]

Thanks, but...

Thanks but I still don't have the answer.

How much, if any, is taxable?

Original Purchase Price: $100,000
Original Mortgage: $95,000
Original 2nd Mortgage: $40,000
Realized from foreclosure sale: $98,000
Balance on 1st mortgage: $94,000
Available for 2nd mortgage: $4,000
Balance on 2nd mortgage: $39,000
Forgiven debt on 2nd mortgage, 1099-C $35,000

TTB actually gives an example, but their series of transactions results in zero gain/loss.

[Gene V]

Snaggletooth,
I haven’t had one of these yet (cross my fingers, that I don’t), However, I ran the numbers with my tax tools program
With both mortgages being Recourse loans.
There answer is as follows.
The last Line, (line 11) of worksheet was for $35,000, there note
At the end said.

Did either or both lenders forgive any portion or all of the debts shown on line 11? If yes, taxpayer has debt relief of the
Amount forgiven. This is ordinary income and must be report
On Form 1040 unless it can be excluded under bankruptcy,
Insolvency, etc. (See Pubs 908 and 4681) Financial institutions
Must report the amount of debt canceled on Form 1099-C

[BP.]

Snaggletooth, had a few Form 982's last year, which worked out fine. Interested in your scenario, since a few more of these could come my way.

How's this:
TTB 14-11- Worksheet for Foreclosures
Line 1 $35,000 Amount of debt cancelled
Line 2 $98,000 FMV (I used selling price) of property
Line 3 Zero
Line 4 $35,000 Smaller of line 1 or 2
Line 5 $65,000 Adjusted basis (I took the $100,000 purchase price and reduced it, i.e. adjusted it, by the $35,000 cancelled debt as required when using Form 982.)
Line 6 ($30,000) Subtract line 5 from line 4.

Therefore, no taxable gain? I may not be correct, and hope we get some more input.

Note line 4 may need to be $133,000, as it asks to include "any proceeds received" from the sale. Was the $98,000 considered proceeds received? Or just sales price. He didn't actually receive proceeds. If so then you are back to your $33,000 original proposed gain.

And, here's a sticking point: TTB 14-11 Last bullet item on top right column- For the portion discharged that is not qualified principal residence debt (i.e. acquisition debt) the amount exceeding forgiven debt cannot be excluded.

So sorry to try to answer your question with more questions, but hopefully it gets closer to the solution.
Barbara

[Gretel]

Thanks but I still don't have the answer.

How much, if any, is taxable?

Original Purchase Price: $100,000
Original Mortgage: $95,000
Original 2nd Mortgage: $40,000
Realized from foreclosure sale: $98,000
Balance on 1st mortgage: $94,000
Available for 2nd mortgage: $4,000
Balance on 2nd mortgage: $39,000
Forgiven debt on 2nd mortgage, 1099-C $35,000

TTB actually gives an example, but their series of transactions results in zero gain/loss.

Under the assumption that the 2nd mortgage is recourse $35,000 is taxable unless insolvency applies.

If 2nd mortgage were non-recourse then no income but I don't think there is any 2nd or even 1st home mortgage out there is not recourse.

[Snaggletooth]

Thanks to All

Thanks to all who participated and volunteered their opinions.

Regards, Snag

[Snaggletooth]

Still having Fits

with this guy's return. From the responses thus far, forgiveness from the second mortgage does not qualify for Principal Residence relief unless it is part of acquisition debt (and it's not).

We now turn to relief because of insolvency. The first mortgage was satisfied, so there is no forgiveness. However, there would have been no forgiveness from the second mortgage had the first mortgage not foreclosed.

Reading from TTB14-11, col. 2, bullet 4: discharge on principal residence is not applicable if taxpayer elects insolvency. Is this an automatic disqualifier, or is it simply a matter of extent (e.g. can't claim both exemptions on the same money)??

Maybe a better question is "How is Insolvency Measured?" He has a $35K on 1099-C, but
after the foreclosure, all he has is a $15K car that he owes $20K. So he is only $5 upside down. However, he is now Unemployed and has health conditions which prevent him from being hired at many places.

All of you are busy, but if you have any special knowledge here, I would appreciate you sharing it. Thanks, Snag

[Jesse]

Check out this link

There are some examples as well. Hope it helps.

http://www.irs.gov/publications/p4681/ch01.html#en_US_publink100080242

Insolvency
Do not include a canceled debt in income to the extent that you were insolvent immediately before the cancellation. You were insolvent immediately before the cancellation to the extent that the total of all of your liabilities exceeded the FMV of all of your assets immediately before the cancellation. For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account). Liabilities include:

The entire amount of recourse debts, and

The amount of nonrecourse debt that is not in excess of the FMV of the property that is security for the debt.


You can use the worksheet on page 6 to help calculate the extent that you were insolvent immediately before the cancellation.

[Snaggletooth]

Works Fine

...and I can finally put this one to rest. Thanks to all. Kudos to:

1) TTB for giving the example of how a $100,000 second mortgage is not forgiven in the same context as acquisition mortgage. TTB 14-11, col. 2 "Example: Scott.."
2) Worksheet on p. 6 of Pub 4681. The key verbage is to calculate "immediately BEFORE the forgiveness." This assures that the amount forgiven will be included in the measurement of insolvency.

Thanks to all.