FORECLOSURE TAXATION
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
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
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

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
Basic Tax Consequences: Non-Recourse
Loan

Straight Property Disposition


Amount Realized = full amount of debt


Amount Realized – Adjusted Cost Basis = Gain
Remember to add this amount into Basis too
No Cancellation of Debt
Loan modification exception.
 See Rev Ruling 91-31 & 92-99

Basic Tax Consequences – Recourse

What is being Taxed?
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

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
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 Today’s economy.
Recourse – Property Disposition

Amount Realized (AR) = FMV of Property
Short
Sale

Deed
AR = Sale Price
In Lieu

AR= Appraised Value
Foreclosure

AR = Gross Foreclosure Bid Price.
Abandonment

AR = Appraised Value.
Basic Tax Consequences – Recourse –
Step 2

Cancellation of Debt

Why is This Income?

Obligation to Repay is Extinguished

Hard to Explain to Clients
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 Foreclosure
100,000
Amount of Canceled Debt to
report on 1099-C
100,000

Basic Tax Consequences - CoD

Exceptions

Gifts

Certain Student Loan Forgiveness Programs

Otherwise Deductible Debt
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
What do you Tell your Client

Anticipate a 1099-A/S and 1099-C.

If you ignore, likely to have IRS assessment


You will need to speak to a tax prof. about this



Automated Substitute for Return
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)
I’ve created this file to assist your tax planner.

Retain this file and give to him or her.
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
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).
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).
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. Comm’r, 683 F.2d
125 (5th Cir. 1982).
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.
Help Your Client Prepare for Tax
Reporting
Help Your Client Prepare for Tax
Reporting

For all transactions:

Include Original Loan Document.

Highlight Any Post Deficiency Judgment Interest Rates
FORECLOSURE TAXATION
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