Is there any reason not to pursue a SS where others have tried?

Question

I just spent an hour talking with an owner 2 months from foreclosure. They have had 2 people try to work their SS magic to no avail. I believe the last one was another investor in the area and the owner shut it down due to the lender wanting to give a 1099 for the full deficiency.

It is an investment property where their company built a home and because they could not sell it before closing the construction loan they took it on as a personal liability. (property and loan in own name(s)

They have agreed to sell me the property through a SS and I will be getting back with them on Monday. 
 
Any thoughts?

Sam M. · Answer

Very true! The first was ....well you know. They put in a retail offer at 274K and the bank countered at 390K. The owner cannot understand why they countered so high. I explained to them that the bank countered with the full amount owed on the property (358k) + costs associated with the transaction which is very typical given the situation.

The second person is an investor and I don't know who they use for their negotiations. They offered 200K and the bank countered at 250K.

Too bad one can't hold realtors accountable for not handling the negotiations properly or delegating such to those with the proper skills. If they do a SS now they will owe tax on 75K-100K more than if they had sold it at the original offer.

Sam M. · Answer

Copied from http://www.jaygetzmissoula.com/index.php?page_id=299

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 lenderâ€™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.

3. I lost my home through foreclosure.  Are there tax consequences?  
          
          There are two possible consequences you must consider: 
          
          Taxable cancellation of debt income.(Note: As stated above, cancellation of debt income is not taxable in the case of non-recourse loans.) 
          A reportable gain from the disposition of the home (because foreclosures are treated like sales for tax purposes).(Note: Often some or all of the gain from the sale of a personal residence qualifies for exclusion from income.) 
          Use the following steps to compute the income to be reported from a foreclosure:
          
          Step 1 - Figuring Cancellation of Debt Income (Note: For non-recourse loans, skip this section.  You have no income from cancellation of debt.)
          
          1. Enter the total amount of the debt immediately prior to the foreclosure.___________
          2. Enter the fair market value of the property from Form 1099-C, box 7. ___________
          3. Subtract line 2 from line 1.If less than zero, enter zero.___________

The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C.  This amount is taxable unless you meet one of the exceptions in question 2.  Enter it on line 21, Other Income, of your Form 1040.
          
          Step 2 â€“ Figuring Gain from Foreclosure
          
          4. Enter the fair market value of the property foreclosed.For non-recourse loans, enter the amount of the debt immediately prior to the foreclosure ________
          5.    Enter your adjusted basis in the property.(Usually your purchase price plus the cost of any major improvements.)                                    ____________
          6. Subtract line 5 from line 4.  If less than zero, enter zero.   
          
          The amount on line 6 is your gain from the foreclosure of your home.  If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income.  If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.

4. I lost money on the foreclosure of my home.  Can I claim a loss on my tax return?   
          
          No.  Losses from the sale or foreclosure of personal property are not deductible.

5.  Can you provide examples?
          
          A borrower bought a home in August 2005 and lived in it until it was taken through foreclosure in September 2007. The original purchase price was $170,000, the home is worth $200,000 at foreclosure, and the mortgage debt canceled at foreclosure is $220,000. At the time of the foreclosure, the borrower is insolvent, with liabilities (mortgage, credit cards, car loans and other debts) totaling $250,000 and assets totaling $230,000.
          
          The borrower figures income from the foreclosure as follows:
          
          Use the following steps to compute the income to be reported from a foreclosure:
          
          Step 1 - Figuring Cancellation of Debt Income (Note: For non-recourse loans, skip this section.  You have no income from cancellation of debt.)
          
          1. Enter the total amount of the debt immediately prior to the foreclosure.___$220,000__
          2. Enter the fair market value of the property from Form 1099-C, box 7. ___$200,000__
          3. Subtract line 2 from line 1.If less than zero, enter zero.___$20,000__
          
          The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C.  This amount is taxable unless you meet one of the exceptions in question 2.  Enter it on line 21, Other Income, of your Form 1040.
          
          Step 2 â€“ Figuring Gain from Foreclosure
          
          4. Enter the fair market value of the property foreclosed.For non-recourse loans, enter the amount of the debt immediately prior to the foreclosure. __$200,000__
          5.  Enter your adjusted basis in the property.(Usually your purchase price plus the cost of any major improvements.)                                        ___$170,000__
          6. Subtract line 5 from line 4.If less than zero, enter zero.___$30,000__

The amount on line 6 is your gain from the foreclosure of your home.  If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income.  If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.
          
          In this situation, the borrower has a tax-free home-sale gain of $30,000 ($200,000 minus $170,000), because they owned and lived in their home as a principal residence for at least two years. Ordinarily, the borrower would also have taxable debt-forgiveness income of $20,000 ($220,000 minus $200,000). But since the borrowerâ€™s liabilities exceed assets by $20,000 ($250,000 minus $230,000) there is no tax on the canceled debt.
          
          Other examples can be found in IRS Publication 544, Sales and Other Dispositions of Assets, under the section â€œForeclosures and Repossessionsâ€.

Sam M. · Answer

Montana is non-recourse. There are no deficiency judgments by the lender who exercised the right of sale to recover the property. The issue of 1099's is hard for me to sort out by research as there is seemingly so much bad info out there.

It seems like a 1099-A (foreclosure) or a 1099-C (SS) are inevitable even in a â€œnon recourse stateâ€. The only out with an investment property is to declare and qualify for insolvency which is complicated to say the least.

Sam M. · Answer

Does it make any difference if the loan is recourse or non?

Sam M. · Answer

Post non-judicial foreclosure judgments in are not legal here in MT other than the junior liens that didn't exercise their right of sale. In this case would be the 2nd for 60K and both are held or at least serviced by JPM Chase.

I need to talk to a tax advisor myself so I get a handle on how the 1099-A (post foreclosure) and 1099-C (post SS) work and the advantage if any of a 1099-C.

Seems there is a lot of conflicting information out there as to how bad a hole someone is in when the lender is foreclosing.

Sam M. · Answer

So a 1099 will be issued in all foreclosure and SS cases in all states whether judicial/non-judicial foreclosure, deficiency or non-deficiency states? I realize it is very complicated as with any other tax law because of different factors such as purchase money loans vs. cash out refi, primary residence vs. investment property etc.

I should talk to a tax advisor myself. I will recommend they seek the advice of a tax pro BEFORE I put time into this one. I already did but it is even more important with this case.

Lesson 1: Don't personally take on your company's liabilities when it is going under. (unless of course it makes sense to someone other than just you)

Jackie Patterson · Answer

Seems to me you need to take into account who the two individuals were "trying to work their short sale magic."  If it was an experienced negotiator I would put more credence in the result they got.  We all know that some negotiators are much better than others.

Doug Haisten · Answer

The issue if the deficency judgement comes into to play because this was an investment property rather than their home?

Richard Graham · Answer

I am no pro but someone correct me if I am wrong but Debt Forgivness act.
States "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. "
This should apply to investment property if they are insolvent.  Please check with a CPA