What am I missing here?

Posted by Stuart A. Bronstein on May 12, 2009, 10:29 am

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Am I missing something concerning the Mortgage Forgiveness Dept Relief
Act of 2007? The upshot is that on foreclosure of someone's residence,
debt not required to be repaid is not considered income as long as the
debt was used to purchase or fix up the house (directly or indirectly,
meaning it went into the basis of the house).

It seems to me that act really had no real effect with respect to
forgiveness of debt income on home mortgages. There should only be
income to the extent the forgiven debt exceeds the debtor's basis in
the property. And if the act only applies to debt that went into or
increased the basis, none of that forgiven debt would have had to be
recognized as income in any case.

So what was the purpose of the statute really? Does it have an actual
effect?

Thanks for your insight.

Stu

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Posted by Alan on May 12, 2009, 11:18 am

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Stuart A. Bronstein wrote:

> Am I missing something concerning the Mortgage Forgiveness Dept Relief

> Act of 2007? The upshot is that on foreclosure of someone's residence,

> debt not required to be repaid is not considered income as long as the

> debt was used to purchase or fix up the house (directly or indirectly,

> meaning it went into the basis of the house).

> It seems to me that act really had no real effect with respect to

> forgiveness of debt income on home mortgages. There should only be

> income to the extent the forgiven debt exceeds the debtor's basis in

> the property. And if the act only applies to debt that went into or

> increased the basis, none of that forgiven debt would have had to be

> recognized as income in any case.

> So what was the purpose of the statute really? Does it have an actual

> effect?

> Thanks for your insight.

> Stu

Your error is where you say "There should only be
income to the extent the forgiven debt exceeds the debtor's basis
in the property."
You seem to have confused two issues: Debt cancellation and gain
or loss on the sale of real property.

If you have a recourse loan on your home and debt is forgiven,
you normally have debt cancellation income. The referenced tax
act allows for forgiveness of that debt if all conditions are
met. Any forgiveness must then be used to lower the cost basis of
the home. The home owner then makes another calculation to
determine whether or not there was a gain on the disposition. If
there was a gain, the home owner can exclude that gain if the two
year rules for excluding gain on your main home are met.

IRS Pub 4681 (Canceled Debts, Foreclosures, Repossessions and
Abandonments) has a very good explanation and examples of the tax
consequences relating to the Pub subject.

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Posted by Stuart A. Bronstein on May 12, 2009, 12:07 pm

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> Stuart A. Bronstein wrote:

>> Am I missing something concerning the Mortgage Forgiveness Dept

>> Relief Act of 2007?

>> It seems to me that act really had no real effect with respect to

>> forgiveness of debt income on home mortgages. There should only

>> be income to the extent the forgiven debt exceeds the debtor's

>> basis in the property. And if the act only applies to debt that

>> went into or increased the basis, none of that forgiven debt

>> would have had to be recognized as income in any case.

> Your error is where you say "There should only be

> income to the extent the forgiven debt exceeds the debtor's basis

> in the property."

> You seem to have confused two issues: Debt cancellation and gain

> or loss on the sale of real property.

Perhaps. But it seems to me that in the case of, say, a single
purchase money loan, when the home is foreclosed on, it's in effect a
sale of the home back to the bank for the amount of the outstanding
debt. In that case how can there be debt cancellation income without
gain? That would be like saying that anyone who sells a house with a
mortgage on it has income in addition to their gain.

> If you have a recourse loan on your home and debt is forgiven,

> you normally have debt cancellation income.

I guess that's part of my problem with this - exactly when is debt
"forgiven"? If someone gives value in exchange for cancellation of
debt, for me that's an exchange and there's only tax if there is
gain.

> IRS Pub 4681 (Canceled Debts, Foreclosures, Repossessions and

> Abandonments) has a very good explanation and examples of the tax

> consequences relating to the Pub subject.

Thanks.

Even that publication says there should only be cancellation of debt
income if the amount owed is less than the fair market value of the
property. So why is there no offsetting loss on the "sale" of
property for less than basis? You may not be able to deduct the loss
from taxes, but shouldn't it be allowed to offset any gain?

Stu

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Posted by Mark Bole on May 12, 2009, 3:19 pm

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Stuart A. Bronstein wrote:

> Perhaps. But it seems to me that in the case of, say, a single

> purchase money loan, when the home is foreclosed on, it's in effect a

> sale of the home back to the bank for the amount of the outstanding

> debt. In that case how can there be debt cancellation income without

> gain? That would be like saying that anyone who sells a house with a

> mortgage on it has income in addition to their gain.

>> If you have a recourse loan on your home and debt is forgiven,

>> you normally have debt cancellation income.

> I guess that's part of my problem with this - exactly when is debt

> "forgiven"? If someone gives value in exchange for cancellation of

> debt, for me that's an exchange and there's only tax if there is

> gain.

The terminology confuses me some times. To be precise, with a
non-recourse loan, the amount of debt canceled becomes the "sales price"
considered to have been received, and there is no *income* from
cancellation of debt (although there will usually be a gain or loss on
the "sale" of the property). With a recourse loan, the sales price
considered to have been received is the FMV, and if the amount of debt
canceled is more than the FMV, the difference is taxable income due to
cancellation of debt.

>> IRS Pub 4681 (Canceled Debts, Foreclosures, Repossessions and

>> Abandonments) has a very good explanation and examples of the tax

>> consequences relating to the Pub subject.

> Thanks.

> Even that publication says there should only be cancellation of debt

> income if the amount owed is less than the fair market value of the

> property.

I believe that is "more than", not "less than". Or give us a page
number in the PDF file to refer to. But otherwise, yes, cancellation of
recourse debt is taxable income to the extent it exceeds the FMV of the
property surrendered. Again, cancellation of non-recourse debt does not
normally lead to any taxable COD income.

As I said before, in reply to your original post, the 2007 tax law had
the effect of making cancellation of recourse debt that met the
requirements end up being treated like non-recourse debt for this
purpose (I'm oversimplifying, but the end result looks the same for tax
purposes). The canceled recourse debt that did not meet the
requirements (acquisition debt on primary residence) still can generate
COD income.

> So why is there no offsetting loss on the "sale" of

> property for less than basis? You may not be able to deduct the loss

> from taxes, but shouldn't it be allowed to offset any gain?

The gain or loss on the "sale", and income from cancellation of debt,
are two different things. The latter is not gain from sale of property.

As we know, the gain on sale of personal residence gets favorable
treatment under both Sec 121 and long-term capital gains tax rates.
Income from cancellation of debt gets no such treatment. The 2007 law
moves some income out of the latter category into the former, under the
right limited conditions -- similar to what would happen with a
non-recourse loan even before the 2007 law.

-Mark Bole

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Posted by Mark Bole on May 12, 2009, 11:24 am

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Stuart A. Bronstein wrote:

> Am I missing something concerning the Mortgage Forgiveness Dept Relief

> Act of 2007? The upshot is that on foreclosure of someone's residence,

> debt not required to be repaid is not considered income as long as the

> debt was used to purchase or fix up the house (directly or indirectly,

> meaning it went into the basis of the house).

> It seems to me that act really had no real effect with respect to

> forgiveness of debt income on home mortgages. There should only be

> income to the extent the forgiven debt exceeds the debtor's basis in

> the property.

That's what you are missing. Before this act, the full amount of
canceled debt was taxable income, now it's not (for three years only,
2007-2009). The amount excluded from income under this law is used to
reduce the basis in the property. The gain if any due to this reduced
basis, however, typically will fall under the normal Sec. 121 exclusion
rule.

> And if the act only applies to debt that went into or

> increased the basis, none of that forgiven debt would have had to be

> recognized as income in any case.

Wrong, prior to the act there was no special rule regarding acquisition
debt on a principal residence. It was all still just cancellation of
debt income.

> So what was the purpose of the statute really? Does it have an actual

> effect?

One way to think of it, is that it has the effect of making short sale
or foreclosure of a house with recourse debt behave as if it were
non-recourse debt for tax purposes.

For states like California which did not conform to the federal law, any
cancellation of debt income excluded on the federal return must be
added back for the state return.

-Mark Bole

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<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
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<< to this newsgroup as well as our anti-spamming policy >>
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