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Slide 2 F ORECLOSURE T AXATION Sean J. Norton Attorney At Law ABA Section of Taxation Public Service Fellow Pine Tree Legal Assistance 39 Green St. Augusta, ME 04330 (207) 400-3252 Direct (207) 482-9212 - Cell sjnorton@ptla.org seanjn@hotmail.com Slide 3 3 Goals / Sections 1.Understand Basic Tax Consequences 2.What you should tell your client about potential tax consequences 3. Help your client prepare for tax reporting Slide 4 Basic Tax Consequences: Recourse v. Non-Recourse Non-recourse loans No Cancellation of Debt Sale/disposition of Property Will Receive a 1099-A if Foreclosure or Property Abandonment; 1099-S if Short-sale Recourse loans Potential cancellation of debt event Sale/disposition of Property Will Receive 1099-A & 1099-C if Foreclosure or Abandonment; 1099-S & 1099-C if Short-Sale Slide 5 Basic Tax Consequences: Recourse v. Non-Recourse 1099-A or S relate to the property disposition/sale. 1099-C relates to cancellation of debt event. With Recourse loans, If both events take place in same calendar year. Then Lender has option to only issue 1099-C with sections 4, 5 & 7 filled out. Ie Sale/disposition of property is recorded in the 1099-C not, 1099-A Slide 6 Basic Tax Consequences: Non-Recourse Loan Straight Property Disposition Amount Realized Adjusted Cost Basis = Gain Amount Realized = full amount of debt Remember to add this amount into Basis too No Cancellation of Debt Loan modification exception. See Rev Ruling 91-31 & 92-99 Slide 7 Basic Tax Consequences Recourse What is being Taxed? Slide 8 Basic Tax Consequences - Recourse Bi-furcated Event Potential for Two Taxable Events Sale or Disposition of Property AR AB = Capital Gain Sec 121 Exclusion Cancellation of Debt Interest and Fees not included. Mortgage Debt Relief Act ( N.B. I refer to this repeatedly through the slides as the Mortgage Home Forgiveness Act) Insolvency Exception Slide 9 Basic Tax Consequences - Recourse Bifurcated Process Sale + Canceled Debt (outstanding amount + interest and fees) = Amount of Debt Outstanding immediately before forgiveness + Interest & fees if cancelation event takes place sometime after foreclosure sale (might include post deficiency judgment interest). Property Disposition = AR AB = Potential For Capital Gain Cancellation of Indebtedness Income = Ordinary Income Rates Slide 10 Basic Tax Consequences - Recourse Start with Property Disposition What is the Amount Realized IRS Pub 4681 Lesser of: FMV or Amount of Loan Outstanding Immediately Before Disposition deficiency judgment. In this lecture: Assume FMV is less. Normal in Todays economy. Slide 11 Recourse Property Disposition Amount Realized (AR) = FMV of Property Short Sale AR = Sale Price Deed In Lieu AR= Appraised Value Foreclosure AR = Gross Foreclosure Bid Price. Abandonment AR = Appraised Value. Slide 12 Basic Tax Consequences Recourse Step 2 Cancellation of Debt Why is This Income? Obligation to Repay is Extinguished Hard to Explain to Clients Slide 13 Basic Tax Consequences - Recourse How to Calculate Cancellation of Indebtedness Income in Foreclosure Setting: CoD Income: Amount of Indebtedness:200,000 FMV of Property at Foreclosure100,000 Amount of Canceled Debt to 100,000 report on 1099-C Slide 14 Basic Tax Consequences - CoD Exceptions Gifts Certain Student Loan Forgiveness Programs Otherwise Deductible Debt Slide 15 Basic Tax Consequences - CoD Exclusions: Bankruptcy Insolvency Qualified principal residence indebtedness added by Mortgage Forgiveness Debt Relief Act of 2007 (MFDRA) for debt cancelled before January 1, 2013. Form 982 Slide 16 What do you Tell your Client Anticipate a 1099-A/S and 1099-C. If you ignore, likely to have IRS assessment Automated Substitute for Return You will need to speak to a tax prof. about this Recommend a CPA or Tax Attorney or Enrolled Agent. Who understands these issues Suggest finding an AARP Tax Prep Volunteer Who is certified to handle CoD income 1-888-687-2277 1-877-434-7598 (TTY) Ive created this file to assist your tax planner. Retain this file and give to him or her. Slide 17 What do you Tell your Client Loan Modification Disclose potential for cancellation of debt Before moving forward with transaction? At time Mod is executed? At closure of case? HAMP and Revenue Procedures Rev Proc 2013-16 Principal reduction alternative Rev Proc 2009-23 HAMP and General Welfare Exclusion Slide 18 What do you Tell your Client Loan Mods, Interest and Capitalization. Rule 1: Interest that is capitalized into principal by the SAME lender (whether or not denoted a modification) remains interest, and should be amortized over the remaining (or new) term of the loan. It has not become principal for tax purposes. See Davison, 107 TC 35 (1996). Slide 19 What do you Tell your Client Loan Mods, Interest and Capitalization. Rule 2. Interest that is capitalized into principal by a DIFFERENT lender at the time of a refinancing is deemed to have been paid at the time of the refinancing and is deductible at that time. See Menz, 80 TC 1174 (1983). Slide 20 What do you Tell your Client Loan Mods, Interest and Capitalization. Thus, It is actually necessary to ascertain the identity of the new lender. With FNMA-type loans, that may have been packaged and repackaged, it is possible that an apparent modification is actually a refinancing. If that is the case, then the interest may become currently deductible. See Franklin v. Commr, 683 F.2d 125 (5th Cir. 1982). Slide 21 What do you Tell your Client Loan Mods, Interest and Capitalization. Final Rule Once the interest has been deducted (or should have been deducted), then its cancellation would be COD. Slide 22 Help Your Client Prepare for Tax Reporting Slide 23 For all transactions: Include Original Loan Document. Highlight Any Post Deficiency Judgment Interest Rates Slide 24 F ORECLOSURE T AXATION Sean J. Norton Attorney At Law ABA Section of Taxation Public Service Fellow Pine Tree Legal Assistance 39 Green St. Augusta, ME 04330 (207) 400-3252 Direct (207) 482-9212 - Cell sjnorton@ptla.org seanjn@hotmail.com