Cancellation of debt as taxable income for short sale on priorresidence turned into rental?

Discussion in 'Tax' started by Matt S., Feb 8, 2011.

  1. Matt S.

    Matt S. Guest

    When is debt forgiveness from short-sale of a property included as
    taxable income?

    Specifics... before we got married, my wife was living in her first
    house for about 19 months. She moved into a 2nd larger house and kept
    the 1st one as a rental.

    Last year she sold the 2nd house in a short sale and the debt
    cancellation of $110,000 was not included as part of our 2010 income
    because it was her primary residence previous to the short sale (and
    our moving in together in a different home).

    We are in the process of selling the 1st house in a short sale...
    expected to close in the next few months (in 2011). She lived in that
    house between 2005 and 2006 for about 19 months. The debt cancellation
    is expected to be about $80,000 to $100,000. Will that be counted as
    income on our 2011 taxes or will it also be ignored because she
    previously lived in that house and it was orginally purchased as a
    residence?

    Would really appreciate links to IRS docs that explain the details.

    Thanks!!
    -Matt

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    Matt S., Feb 8, 2011
    #1
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  2. Matt S.

    Guest

    On Feb 7, 5:07 pm, "Matt S." <> wrote:

    > When is debt forgiveness from short-sale of a property included as
    > taxable income?


    See http://www.irs.gov/newsroom/article/0,,id=174034,00.html

    > Specifics... before we got married, my wife was living in her first
    > house for about 19 months. She moved into a 2nd larger house and kept
    > the 1st one as a rental.


    It looks like the mortgage forgiveness act only applies to your
    primary home. If you've moved back into the smaller home after
    selling the larger one, then it is now your primary residence. The
    law probably addresses rental homes turned into primary residence
    homes (ie. maybe the mortgage forgiveness does not apply), but I don't
    know the details.

    > Last year she sold the 2nd house in a short sale and the debt
    > cancellation of $110,000 was not included  as part of our 2010 income
    > because it was her primary residence previous to the short sale (and
    > our moving in together in a different home).
    >
    > We are in the process of selling the 1st house in a short sale...
    > expected to close in the next few months (in 2011). She lived in that
    > house between 2005 and 2006 for about 19 months. The debt cancellation
    > is expected to be about $80,000 to $100,000. Will that be counted as
    > income on our 2011 taxes or will it also be ignored because she
    > previously lived in that house and it was orginally purchased as a
    > residence?


    If the debt is non-recourse it is not included in 1099-C. If you're
    in bankruptcy, the debt is not included. If you're in insolvency then
    part of the debt is not included. See section 2 in the link I sent
    you.

    <Quote>

    2. Is Cancellation of Debt income always taxable?

    Not always. There are some exceptions. The most common situations when
    cancellation of debt income is not taxable involve:

    * Bankruptcy: Debts discharged through bankruptcy are not
    considered taxable income.
    * Insolvency: If you are insolvent when the debt is cancelled,
    some or all of the cancelled debt may not be taxable to you.You are
    insolvent when your total debts are more than the fair market value of
    your total assets.Insolvency can be fairly complex to determine and
    the assistance of a tax professional is recommended if you believe you
    qualify for this exception.
    * Certain farm debts:If you incurred the debt directly in
    operation of a farm, more than half your income from the prior three
    years was from farming, and the loan was owed to a person or agency
    regularly engaged in lending, your cancelled debt is generally not
    considered taxable income.The rules applicable to farmers are complex
    and the assistance of a tax professional is recommended if you believe
    you qualify for this exception.
    * Non-recourse loans:A non-recourse loan is a loan for which the
    lender’s only remedy in case of default is to repossess the property
    being financed or used as collateral.That is, the lender cannot pursue
    you personally in case of default.Forgiveness of a non-recourse loan
    resulting from a foreclosure does not result in cancellation of debt
    income.However, it may result in other tax consequences, as discussed
    in Question 3 below.

    </Quote>

    --
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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. >>
    << >>
    << The Charter and the Guidelines for submitting posts >>
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    , Feb 8, 2011
    #2
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  3. Matt S.

    Alan Guest

    On 2/7/11 6:07 PM, Matt S. wrote:
    > When is debt forgiveness from short-sale of a property included as
    > taxable income?
    >
    > Specifics... before we got married, my wife was living in her first
    > house for about 19 months. She moved into a 2nd larger house and kept
    > the 1st one as a rental.
    >
    > Last year she sold the 2nd house in a short sale and the debt
    > cancellation of $110,000 was not included as part of our 2010 income
    > because it was her primary residence previous to the short sale (and
    > our moving in together in a different home).
    >
    > We are in the process of selling the 1st house in a short sale...
    > expected to close in the next few months (in 2011). She lived in that
    > house between 2005 and 2006 for about 19 months. The debt cancellation
    > is expected to be about $80,000 to $100,000. Will that be counted as
    > income on our 2011 taxes or will it also be ignored because she
    > previously lived in that house and it was orginally purchased as a
    > residence?


    There is no cancellation of debt income unless the debt is a recourse
    loan. If it is a recourse loan, there is no exclusion available for the
    cancellation of qualified residential mortgage debt because it is not
    the disposition of her main home. It is the disposition of residential
    rental property. She may elect to exclude this type of debt under the
    rules for cancellation of “qualified real property business
    indebtedness”. See IRC Section 108(a)(1)(D) and 108(c). The maximum
    amount to be excluded is limited to the adjusted basis of depreciable
    real property before the discharge. The definition of qualified debt is
    the same as it is for principal residence debt (amount borrowed to
    build, acquire or make capital improvements). Note that if the rental
    was used by the taxpayer for more than 14 days in the year, it is
    disqualified from this provision. See CCA 200919035, February 20, 2009.
    The disposition of business property is accounted for on Form 4797.

    Also see pages 7 & 10 in IRS Pub 4681: Qualified Real Property Business
    Indebtedness for more information. I also recommend you seek
    professional help for this disposition, as accounting for the
    disposition of rental property and debt cancellation can get quite
    complicated.


    --
    Alan
    http://taxtopics.net

    --
    << ------------------------------------------------------- >>
    << 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. >>
    << >>
    << The Charter and the Guidelines for submitting posts >>
    << to this newsgroup as well as our anti-spamming policy >>
    << are at www.asktax.org. >>
    << Copyright (2011) - All rights reserved. >>
    << ------------------------------------------------------- >>
     
    Alan, Feb 8, 2011
    #3
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