Recourse and Nonrecourse Debt: How to Analyze

People who have homes that are going into foreclosure have enough things to consider. Once they are forced to vacate their properties they then need t...

 

People who have homes that are going into foreclosure have enough things to consider. Once they are forced to vacate their properties they then need to address any tax issues they may be facing. To determine any tax issues, they must review their financial and tax situation.

An important consideration should be whether or not the loan on the property is recourse or nonrecourse.  Recourse mortgages allow the lender to pursue any deficiency balance against the borrower. These loans can result also in forgiveness of debt income.  Many states have enacted laws (anti-deficiency statutes) that can protect certain borrowers.

Mortgages are nonrecourse if the real property is the only collateral for the mortgage instrument and the financial institution cannot pursue the taxpayer personally to satisfy the deficiency balance. For nonrecourse mortgages, since the financial institution can only take back the property in full satisfaction of the debt, there may not be debt that is forgiven (depending on the borrowers circumstances).

Just determining that you have a nonrecourse mortgage does not mean that you are through with your tax analysis. This only addresses potential debt cancellation income.  One other step involves calculating the gain or loss on the property as a result of the disposition. Many folks don’t realize that this is even an issue.

Even if you have recourse debt there may be an exclusion that you will qualify for that will enable you to avoid a tax problem. The Mortgage Forgiveness Debt Relief Act was enacted to help homeowners in these situations. You need to determine if the debt was qualified principal residence debt (as defined in the Act) and, if so, you can possibly exclude the debt forgiveness from taxable income.

These calculations are often more difficult then you might think.  In fact, many CPAs are unclear as to the tax implications for many short sales and or foreclosures.  The issue is that they have just not faced these transactions in such large quantities.  It comes down to not being familiar with many of the transactions.  To complicate the issue further, the banks who issues 1099-Cs or 1099-As often issue them with conflicting or inaccurate information.  In many situations, it seems as though the clerks in their reporting departments are just processing the forms without much regard for accuracy.

Analyzing the tax consequences of foreclosures in today’s environment can be tough.  Make sure you hire a professional and get the IRS forms completed right the first time.

For a FREE debt settlement review call us today at 1-877-536-9421.

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