Property Taxes Added to Loan

[JohnH]

I believe we had a discussion on this matter before, but I can't turn it up in a search.

Taxpayer defaulted on a home loan in mid-2011 due to unforseen financial reverses. Paid about $13,000 in payments on their home mortgage in 2011, but stopped paying at mid-year and home is now in process of foreclosure (or possibly deed-in lieu of foreclosure - that process is undecided at this point).

Lender paid the property taxes late in the year and added the amount paid to the loan balance. Can taxpayer deduct the property taxes on their 2011 tax return?

[Possi]

Lender paid

Taxpayer stopped paying on the loan before the taxes were paid.

If the lender paid the taxes, added it to the loan that is not being paid by the taxpayer, I don't imagine "Taxes Paid" will be reflected on the 1098.

Wouldn't the documentation for the tax deduction be taxpayer's proof of personal payment or the 1098? If taxpayer has neither, I would not take it.

[JohnH]

You nailed the question, which is "If the lender pays the taxes and adds to the loan balance, is that considered payment by the taxpayer?"

If the taxpayer pays by credit card, then there's no question they can deduct the taxes. So the question in my mind is how would payment by credit card differ from payment by adding the taxes to the loan balance? Incidentally, I did go to the Tax Assesor's web site and confirmed that the taxes were paid in 2011.

With all the forecolsures and loan defaults taking place around the country, it seems to me this would be a common occurrence. However, I haven't been able to find any guidance on it anywhere.

[Possi]

Credit card

If the credit card payment was made, or expected to be paid, there would be no question.

In your case, TP is not paying the loan, and is not expected to pay the loan.

[JohnH]

Good point. However, intent is an unknown at the time they payment is made and it won't affect the final outcome. When & if the taxpayer receives a 1099-C, the property taxes will be a part of the forgiven debt and therefore considered taxable income at that time, regardless of what the taxpayers' intent may have been.

The 1099-C amount may be excludible form income due to personal residence or insolvency, but that doesn't change the fact that the property taxes are included in the income figure on the 1099-C to begin with.

I ran across this line of reasoning on another forum and I'm not saying it is correct, but certainly interesting.

[Possi]

1098?

So, was it included on the 1098?

[JohnH]

No it wasn't, but the 1098 already has errors on it. I suspect lenders are confused about these issues as well. The 1098 is a good guide, but it isn't the final determinant. Only the facts & circumstances count.

[Possi]

Interesting

I'll be interested in seeing the final word. I would not take the deduction, but that is mainly because I don't argue tax law like much SMARTER professionals!

Have to run out, family emergency..

[JohnH]

Wait, I am discussing this with a SMARTER professional.

(Hope the family emergency isn't too serious)

[Gary2]

Good point. However, intent is an unknown at the time they payment is made and it won't affect the final outcome. When & if the taxpayer receives a 1099-C, the property taxes will be a part of the forgiven debt and therefore considered taxable income at that time, regardless of what the taxpayers' intent may have been.

The 1099-C amount may be excludible form income due to personal residence or insolvency, but that doesn't change the fact that the property taxes are included in the income figure on the 1099-C to begin with.

This makes sense to me. However, I question whether any portion of the 1099-C amount attributed to the taxes paid will be eligible for the personal residence exclusion, since it's not acquisition debt. Of course, if it's pro-rated as a proportion of total principal before cancellation, it could be a tiny amount, not worth worrying about.

[WhiteOleander]

Ok, I haven't looked this up.But, don't the instructions for canceled debt say that if the debt would have been deductible, it is not included into the income? (I'm not saying it exactly as it is explained.)

[taxea]

Whoever takes over the loan takes the deduction on the taxes at that time. If it remains in the loan then it needs to be allotted over the length of the loan.

[Gary2]

Ok, I haven't looked this up.But, don't the instructions for canceled debt say that if the debt would have been deductible, it is not included into the income? (I'm not saying it exactly as it is explained.)

That applies in situations where it would not have been proper to deduct the expense at the time the credit was applied against the expense. There's an example in Pub. 4681 using the case of getting accounting services on credit. Although the example doesn't point this out, I believe it's relying on the distinction between second-party and third-party credit.

So, for example, suppose a cash-basis general contractor buys lumber at a lumber yard, which extends a line of credit directly. That's second-party credit (seller and lender are the same), and being cash basis, the contractor can't deduct it until paid. If the debt is canceled by the lumber yard, it is excluded from income. But if, instead, the contractor uses a credit card or bank line of credit, that's third-party credit, deductible immediately by the contractor, and is subsequently the debt to the bank or credit card is canceled, then it is included in income.

[Burke]

Good point. However, intent is an unknown at the time they payment is made and it won't affect the final outcome. When & if the taxpayer receives a 1099-C, the property taxes will be a part of the forgiven debt and therefore considered taxable income at that time, regardless of what the taxpayers' intent may have been.

The 1099-C amount may be excludible form income due to personal residence or insolvency, but that doesn't change the fact that the property taxes are included in the income figure on the 1099-C to begin with.

I ran across this line of reasoning on another forum and I'm not saying it is correct, but certainly interesting.

And to chime in with another example, I have had clients whose loans had negative escrow balances because the bank paid the taxes but did not have enough on hand to cover them, and the TP's did deduct them -- they were shown on the 1098, and the bank increased their payment to cover the shortage until satisfied.