COD Income Example

[Harvey Lucas]

Client is single and makes about 75,000/year on a W2.

Client bought a rental house in 2007 and paid 375,000.

Down payment of 50,000, 1st mortgage was 325,000.

FMV of house in 2012 is now 225,000.

Client has an offer from a buyer to sell at 225,000 on a short sale, and the sale would close January 2013.

Bank of America, the holder of the 1st mortgage, will agree to accept the short sale offer and will not pursue my client for the short payoff. The approx current principle payoff balance is 320,000.

Also owing on the 1st mortgage will be approx 19,000 in unpaid interest since client stopped making mortgage payments in March of 2012.

If I understand the process correctly, we would report this on his 2013 1040 as two separate items.

First,,, we would list the sale on 4797..…Sale Price of 225,000...Orig cost 375,000,,, less depreciation 36,000,,, leaves 339,000,,,
add to that estimated exp’s of sale 20,000,,,, for adjusted basis of 359,000.
So on 4797 we have SP 225,000, less adjusted basis 359,000, for a loss of <134,000>

Second,,,we will report COD Income on line 21 of 1040.....we expect to receive a 1099C from Bank of America…past experience dictates that it will be a “surprise” what is on it,,,however,,,,one possibility is that it will say that COD income is 134,000,,,,ie,,,,Principle balance 320,000,,,plus unpaid interest 19,000,,,makes 339,000….net proceeds from the short sale after exp’s of sale should be about 205,000,,,ie sale price 225,000,,,less exp’s of sale 20,000,,,makes proceeds available to pay bank approx 205,000,,,,
339,000 debt,,,less 205,000 proceeds,,,leaves COD Income on 1099C at 134,000..

However, of the 134,000 1099C amount, 19,000 is unpaid interest, that, if paid would be a deduction on the schedule E, so as such, we adjust the 134,000 downward by 19,000 which gives us 115,000 to report on 1040 line 21 other income..

The 1099C should indicate that the FMV of the property was 225,000 since that is what the property actually sold for, but past experience indicates that almost any number can appear in this field.

The client is not insolvent.

The client does not intend to file bankruptcy.

So in summary, on 1040 we will have:
line 21 other income 115,000,
and 4797 loss of <134,000>

There are so many aspects of the COD Income puzzle that baffle me.

I am hoping that I am at least in the ballpark here.

Any advice and insight will be helpful.

Thank you.

Harvey Lucas

[appelman]

Sounds about right.

Unless he qualifies for an exclusion on Form 982. Make sure that they get it right on the 1099C.

[veritas]

The cancelled debt

Goes on Schedule E according to the instructions.

How you do it, I have no idea.

Secondly if it doesn't show up on line 21 you know you will get a letter.

[appelman]

May need it in 2 places

Putting it on Schedule E has the advantage of being sure to liberate any suspended passive losses without having to fiddle the software. But I would also put it on line 21, perhaps like so:

Form 1099C $XXX
Transferred to Sched E -$XXX

[veritas]

The other assumption is

Client is single and makes about 75,000/year on a W2.

Client bought a rental house in 2007 and paid 375,000.

Down payment of 50,000, 1st mortgage was 325,000.

FMV of house in 2012 is now 225,000.

Client has an offer from a buyer to sell at 225,000 on a short sale, and the sale would close January 2013.

Bank of America, the holder of the 1st mortgage, will agree to accept the short sale offer and will not pursue my client for the short payoff. The approx current principle payoff balance is 320,000.

Also owing on the 1st mortgage will be approx 19,000 in unpaid interest since client stopped making mortgage payments in March of 2012.

If I understand the process correctly, we would report this on his 2013 1040 as two separate items.

First,,, we would list the sale on 4797..…Sale Price of 225,000...Orig cost 375,000,,, less depreciation 36,000,,, leaves 339,000,,,
add to that estimated exp’s of sale 20,000,,,, for adjusted basis of 359,000.
So on 4797 we have SP 225,000, less adjusted basis 359,000, for a loss of <134,000>

Second,,,we will report COD Income on line 21 of 1040.....we expect to receive a 1099C from Bank of America…past experience dictates that it will be a “surprise” what is on it,,,however,,,,one possibility is that it will say that COD income is 134,000,,,,ie,,,,Principle balance 320,000,,,plus unpaid interest 19,000,,,makes 339,000….net proceeds from the short sale after exp’s of sale should be about 205,000,,,ie sale price 225,000,,,less exp’s of sale 20,000,,,makes proceeds available to pay bank approx 205,000,,,,
339,000 debt,,,less 205,000 proceeds,,,leaves COD Income on 1099C at 134,000..

However, of the 134,000 1099C amount, 19,000 is unpaid interest, that, if paid would be a deduction on the schedule E, so as such, we adjust the 134,000 downward by 19,000 which gives us 115,000 to report on 1040 line 21 other income..

The 1099C should indicate that the FMV of the property was 225,000 since that is what the property actually sold for, but past experience indicates that almost any number can appear in this field.

The client is not insolvent.

The client does not intend to file bankruptcy.

So in summary, on 1040 we will have:
line 21 other income 115,000,
and 4797 loss of <134,000>

There are so many aspects of the COD Income puzzle that baffle me.

I am hoping that I am at least in the ballpark here.

Any advice and insight will be helpful.

Thank you.

Harvey Lucas

This is a recourse loan.

[appelman]

Almost always true for rental property

I do believe.

[veritas]

I agree

I do believe.

But if it is converted from a personal residence and the home has not been refinanced it could be a nonrecourse loan.

[Harvey Lucas]

Recourse, Non-Recourse ???

Do we have a good definition of the diference between a "Recourse Loan", and a "Non-Recourse Loan"???

In many of the cases I have seen, it is not really clear which is which, and at what time in the process you make the determination.

For instance, I have another client who is in process of either short selling her home, or, allowig it to go into foreclosre.

As she understands it, if she allows the Bank to do a simple forclosure, they will not come after her for the shortage that will result when they later sell the property for less than what she owes. They could if they wanted to (according to them), but they have indicated that they will not. So the loan is Recourse now, but becomes Non-Recourse later when they elect to not pursue her for the shortage??

If she does a "short sale", ie, she finds a buyer who will buy the home for less than what is owed, but the bank has to agree to accept the amount..in this case it is a negotiable issue as to wether she will owe them any unpaid amounts, however, if they will not agree to relieve her of the shortage, she has the option to cancel the short sale..So in other words, it is Recourse up untill the bank decides it is Non-Recourse...this being the case, what method do we use in determing the taxation under the two methods described in TB?

Finally, if she brings a suit against the bank, for some of the reasons that you hear about in the media, ie, robo signing, non participation in loan modification procedures, etc, etc...then the bank will go the route of a "judicial forclosure"..they say if they are forced to do a "judicial forclosure", then they will insist that she does pay any shortage on the mortgage payoff...so now it becomes "recourse" again???

Do we have anything conclusive on this particular area of the issue? ie, what exactly do they mean by "Recourse" and "Non-Recourse" and at what stage of the short sale/forclosure process is that determination made?

Harvey Lucas

[veritas]

My understanding is

If a promissory note is signed, you have a recourse note. Where only a trust deed is signed you have a non recourse loan.

I have been taught that in Oregon when you purchase a residence initially there is no promissory note. When a property is refinanced nearly always a promissory note is signed.

http://www.forecloseddreams.com/recourse_states

[Gary2]

Do we have a good definition of the diference between a "Recourse Loan", and a "Non-Recourse Loan"???

In many of the cases I have seen, it is not really clear which is which, and at what time in the process you make the determination.

It's (primarily) determined when the loan papers are signed, and not by later events.

For instance, I have another client who is in process of either short selling her home, or, allowig it to go into foreclosre.

As she understands it, if she allows the Bank to do a simple forclosure, they will not come after her for the shortage that will result when they later sell the property for less than what she owes. They could if they wanted to (according to them), but they have indicated that they will not. So the loan is Recourse now, but becomes Non-Recourse later when they elect to not pursue her for the shortage??

If she does a "short sale", ie, she finds a buyer who will buy the home for less than what is owed, but the bank has to agree to accept the amount..in this case it is a negotiable issue as to wether she will owe them any unpaid amounts, however, if they will not agree to relieve her of the shortage, she has the option to cancel the short sale..So in other words, it is Recourse up untill the bank decides it is Non-Recourse...this being the case, what method do we use in determing the taxation under the two methods described in TB?

Finally, if she brings a suit against the bank, for some of the reasons that you hear about in the media, ie, robo signing, non participation in loan modification procedures, etc, etc...then the bank will go the route of a "judicial forclosure"..they say if they are forced to do a "judicial forclosure", then they will insist that she does pay any shortage on the mortgage payoff...so now it becomes "recourse" again???

If you take your line of reasoning to the extreme conclusion, there would never be any recourse canceled debt - because the issuing of a 1099-C should always be coupled to some event or action indicating that the lender is not going to be able to recover the debt. But "recourse vs. non-recourse" is a quality of the legal rights of the lender, not the policies or decision processes of the lender, nor of subsequent events. For example, bankruptcy doesn't convert a loan to non-recourse, even though bankruptcy will usually eliminate the lender's right to recover.

For a more detailed example, see Dave Fogel's article "Does a Non-Judicial Foreclosure Convert Debt From Recourse to Non-Recourse?" (bearing in mind that the article deals with debt that starts out as recourse, and not the typical California purchase mortgage for a home, which starts out as non-recourse in CA).

In rare cases, it's possible that a lender may be able to recover subsequent to a 1099-C (in which case, any canceled debt declared as income and subsequently repaid is treated as a claim of right, while adjusted tax attributes will have to be unadjusted).

[Gary2]

If a promissory note is signed, you have a recourse note. Where only a trust deed is signed you have a non recourse loan.

That's may be a state-specific or practice-specific generalization. I've never heard of any law that would prevent a borrower and lender from negotiating a non-recourse promissory note. A trust deed is specifically a mechanism for enabling non-judicial foreclosure. I don't know whether a trust deed will include the terms of the loan as well, nor whether there's any general law that prevents recourse with judicial foreclosure when there's a trust deed.

Which is not to say that you shouldn't use such generalizations for typical home mortgages. Massachusetts is a recourse state, even though most foreclosures are non-judicial. I view it as the client's job to tell me if they have an unusual, non-recourse loan (theoretically possible), not my job to read the legalese for a very unlikely case.

[veritas]

We are

A non recourse state.

It would seem to me to be a waste of time to sign a non recourse promissory note. What benefit would it be to a lender?

[Harvey Lucas]

List of States

Regarding first mortgages for original purchase of primary residence.

Can all states be classified as "Recourse States", or "Non-Recourse States" ?

Does anyone know of a list of all the States to that effect?

Harvey Lucas.

[veritas]

I posted a link

Regarding first mortgages for original purchase of primary residence.

Can all states be classified as "Recourse States", or "Non-Recourse States" ?

Does anyone know of a list of all the States to that effect?

Harvey Lucas.

Above......

[Harvey Lucas]

Great website Veritas!

Thanks for the link Veritas, very useful and helpful.

Harvey Lucas