Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss
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Cancellation of Debt (COD) R. Bruce McCommons Harford County, MD TrC 12/4/2013 rbrucemcc@comcast.net 1 Cancellation of debt (COD)... Generally, if a debt for which the taxpayer was personally responsible is canceled, the amount canceled is considered income, and is reported on the 1040, line 21, Other income... Examples of such debt are... • Auto loans... • Credit card purchases... • Installment loans... • Mortgages... • Home equity loans Only two types of COD are considered in scope for our program... • Qualified principal residence debt… • Non-business credit card debt 2 Cancellation of debt (COD)... Some canceled or forgiven debt may be eliminated from income by applying exceptions, or reduced by applying exclusions to the general rule—exceptions are always applied before exclusions... Exceptions... • Amounts not included in income, e.g., gifts and bequests... • Certain student loans... • Deductible debt, e.g., home mortgage interest... • Price reduced after purchase, e.g., seller reduces debt Exclusions... • Discharge of debt through bankruptcy... • Discharge of debt of an insolvent taxpayer... • Discharge of qualified farm indebtedness... • Discharge of qualified real property business indebtedness... • Discharge of qualified principal residence indebtedness The only In-Scope situation for our program is discharge of qualified 3 principal residence indebtedness Cancellation of debt (COD)... Mortgage Debt Forgiveness Relief Act... • Enacted in 2007, and is scheduled to expire in 2013… • Allows taxpayers to exclude from income certain debt forgiveness regarding their principal residence... Two situations... • Foreclosure/abandonment—takeover of home by lender, homeowner moves out and loses home... • Debt reduction—mortgage amount is reduced by negotiation with lender, and homeowner keeps possession of home; commonly referred to as a “workout” 4 Mortgage Debt Forgiveness Relief Act... Foreclosures, abandonment, and debt cancellation... • If the property was “taken,” by the lender, it is a foreclosure... • If the property was “given up,” by the borrower, it is an abandonment... • In both situations, the lender will issue a Form 1099-A, Acquisition or Abandonment of Secured property... • If a debt greater than $600 is canceled, the lender will issue a Form 1099-C, Cancellation of Debt... • If the foreclosure/abandonment and debt cancellation occur in the same calendar year, the lender has the option of issuing only a Form 1099-C 5 Mortgage Debt Forgiveness Relief Act... Conditions required to allow exclusion of forgiven debt from income... • The debt must be a mortgage used to buy, build, or substantially improve a principal residence... • The mortgage was secured by the taxpayers principal residence... • The money must not have been used to pay off credit card debt, medical bills, vacations, etc... • The residence was never used in a business or as rental property... • Residence was not a vacation home... • Exclusion limit is $2M ($1M if filing MFS)... Considered Out of Scope for our program if the taxpayer received... • A 1099-C, and there is an entry in Box 3 (Interest).. • A 1099-C, and there is an entry in Box 6 entry (Bankruptcy) 6 Mortgage Debt Forgiveness Relief Act, foreclosures... Foreclosures and abandonments... • Treated as a “sale” of the home to the lender by the buyer... • Lender issues a 1099-A to the seller, or, more likely, a 1099-C, or, less likely, a 1099-A and a 1099-C... • Sale is reported on Schedule D, and could be a loss or a gain... If there is a loss, it is not deductible... If there is a gain, which is very unlikely, it may be taxable, but that is also unlikely because of the Section 121 Exclusion 7 Mortgage Debt Forgiveness Relief Act, foreclosures... Two types of debt... • Recourse debt—debtor is responsible for the amount not satisfied by the “sale” of the property... A capital loss is most likely, but a gain is possible... Taxpayer would receive a 1099-A, a 1099-C, or both… If a 1099-A, the selling price is the smaller of Box 2 or Box 4, the FMV; if a 1099-C, the selling price is Box 7, the FMV • Non-recourse debt—debt is satisfied by the “sale” of the property… A capital gain or loss is possible... Taxpayer would receive a 1099-A; the selling price is Box 2... Since there is no canceled debt, the taxpayer would not receive a 1099-C • Most debts are recourse, but rules vary from state to state... 8 Recourse versus non-recourse states... Non-recourse states Recourse states Alaska (AK) Arizona (AZ) California (CA) Connecticut (CT) Florida (FL) Idaho (ID) Minnesota (MN) North Carolina (NC) North Dakota (ND) Oregon (OR) South Dakota (SD) Texas (TX) Utah (UT) Washington State (WA) Alabama (AL) Arkansas (AR) Colorado (CO) Delaware (DE) District of Columbia (DC) Georgia (GA) Hawaii (HI) Illinois (IL) Iowa (IA) Indiana (IN) Kansas (KS) Kentucky (KY) Louisiana (LA) Maine (ME) Maryland (MD) Massachusetts (MA) Michigan (MI) Montana (MT) Mississippi (MS) Missouri (MO) Ohio (OH) Nebraska (NE) Nevada (NV) New Hampshire (NH) New Jersey (NJ) New Mexico (NM) New York (NY) Oklahoma (OK) Pennsylvania (PA) Puerto Rico (PR) Rhode Island (RI) South Carolina (SC) Tennessee (TN) Vermont (VT) Virginia (VA) West Virginia (WV) Wisconsin (WI) Wyoming (WY) 9 Mortgage Debt Forgiveness Relief Act, foreclosures... 1099-A 13 Recourse debt if checked 1099-C Nonrecourse debt if not checked 11 13 10 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... Fred buys a house in 2003 for $175,000, later loses his job, and stops making mortgage payments. On 6 June 2013, the bank forecloses on the home and cancels the amount remaining on the mortgage. At the time of foreclosure, Fred owed $150,000, but the Fair Market Value (FMV) of the house was only $100,000. Fred gets a 1099-A from the bank... 13 Bank of America 6/6/2013 Fred Smith 150,000.00 100,000.00 X 123 Oak Street Edgewood, MD 21040 123 Main Street Bel Air, MD 21015 Must complete the Cap Gn Wkt which will flow to the appropriate 8949 11 and the Sch D... Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... Enter information on the Cap Gn Wkt, as shown... In Column (a), Description, enter “FORECLOSED HOME”... In Column 1099, enter “C” because no 1099-B was received... In Column (b), Date acquired, enter 06/06/2003, date Fred bought the house... In Column (c), Date sold, enter 06/06/2013, i.e., 1099-A, Box 1... In Column (d), Sales price, enter 100,000, i.e., 1099-A, Box 4, FMV... In Column (e), Cost, enter 175,000, i.e., what Fred paid for the house... In Column (f), Code, enter “L” because no loss is allowed... In Column (g), Adjustments, enter 75,000, i.e., the disallowable loss... Column (h), Gain or Loss will now show zero, and you are finished 12 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... The 8949 Pg2 [Long: 1099-B not received] will look like this... US 8949 (2013) 13 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... And the Sch D, Part II, will look like this... 14 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... If a personal residence is abandoned or foreclosed and the debt is canceled in the same year, the taxpayer may receive a 1099-C instead of a 1099-A. If Fred had received a 1099-C, it would have looked like this... Bank of America 6/6/2013 50,000.00 13 Home mortgage loan Fred Smith 123 Oak Street Edgewood, MD 21040 X 100,000.00 Must complete the Cap Gn Wkt which will flow to the appropriate 8949 and the Sch D; additionally, must complete a Form 982, and the $50,000 15 is not reported on line 21, Other income... Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... Enter information on the Cap Gn Wkt, as shown... In Column (a), Description, enter “FORECLOSED HOME”... In Column 1099, enter “C” because no 1099-B was received... In Column (b), Date acquired, enter 06/06/2003, date Fred bought the house... In Column (c), Date sold, enter 06/06/2013, i.e., 1099-C, Box 1, Date Cancelled... In Column (d), Sales price, enter 100,000, i.e., 1099-C, Box 7, FMV... In Column (e), Cost, enter 175,000, i.e., what Fred paid for the house... In Column (f), Code, enter “L” because no loss is allowed... In Column (g), Adjustments, enter 75,000, i.e., the disallowable loss... Column (h), Gain or Loss will now show zero, and you are finished 16 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... The 8949 Pg2 (Long-term, 1099-B not received) will look like this... US 8949 (2013) 17 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... And the Sch D, Part II, will look like this... 18 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a loss... Fred’s Form 982... Check Box 1e... Line 2, Total amount of debt canceled from the 1099-C, Box 2... Line 3, not applicable—if red, F3 to get the red out... No entry in line 10b because ownership was not retained... 19 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a gain... Fred buys a house in 2003 for $200,000 and obtains a nonrecourse loan. He later loses his job and stops making mortgage payments. On 13 December 2013, the bank forecloses on his home. At the time of foreclosure, Fred owed $185,000 on the home, its FMV was $170,000, and his adjusted basis was $175,000 due to a casualty loss he deducted on his 2008 tax return. Fred gets a 1099-A from the bank... 13 Bank of America 12/13/2013 Fred Smith 123 Oak Street Edgewood, MD 21040 185,000.00 170,000.00 X While not absolutely necessary because the exclusion would probably 20 never be exceeded, should complete the Sch D Wkt2 (Sale of Home)... Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a gain... Fred’s completed Sch D Wkt 2 Date sold... Date bought... Selling price (for a nonrecourse loan, the amount from the 1099-A, Box 2)... Adjusted basis... Excludable gain... Allowable exclusion... Taxable gain... Next, must enter the transaction into the Cap Gn Wkt which will flow to 21 the 8949 and the Sch d… Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a gain... Enter information on the Cap Gn Wkt, as shown... In Column (a), Description, enter “FORECLOSED HOME”... In Column 1099, enter “C” because no 1099-B was received... In Column (b), Date acquired, enter 10/12/2003, date Fred bought the house... In Column (c), Date sold, enter 12/13/2013, i.e., 1099-A, Box 1... In Column (d), Sales price, enter 185,000, i.e., 1099-A, Box 2... In Column (e), Cost, enter 175,000, i.e., Fred’s adjusted basis in the house... In Column (f), Code, enter “H” for Section-121 Exclusion... In Column (g), Adjustments, enter -10,000, i.e., the Section-121 exclusion... Column (h), Gain or Loss will now show zero, and you are finished 22 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a gain... The 8949 Pg2 (Long-term, 1099-B not received) will look like this... 23 Mortgage Debt Forgiveness Relief Act, foreclosure and sale is a gain... And the Sch D, Part II, will look like this... 24 Mortgage Debt Forgiveness Relief Act, workout... Fred buys a house in 2005 for $150,000, becomes ill, and can only work part time. When he starts to have trouble making his monthly mortgage payments, he goes to his bank and explains his situation. His bank, rather than go through the expense of a foreclosure, agrees to lower his principal to $120,000 and refinance the loan. Tom gets a 1099-C from the bank... Harford Bank 10/31/2013 30,000.00 13 Home mortgage loan Fred Smith 123 Oak Street X Edgewood, MD 21040 Must complete Form 982 and the $30,000 is not be reported on the 25 1040, line 21, Other income—Sch D is not required Mortgage Debt Forgiveness Relief Act, workout... Fred’s Form 982... Check box 1e... Amount of debt canceled from the 1099-C, Box 2... Not applicable, if red, F3 to get the red out... Amount of debt canceled from the 1099-C, Box 2, is entered on line 10b; reduces the basis of the home when eventually sold 30000 30000 26 Mortgage Debt Forgiveness Relief Act, canceled debt... Summary of general principles for most likely cases... • The bank forecloses or the buyer abandons a principal residence and the buyer loses the home... Taxpayer receives a 1099-A: we complete a... Cap Gn Wkt, which flows to an 8949 and the Sch D Taxpayer receives a 1099-C: we complete a... Cap Gn Wkt, which flows to an 8949 and the Sch D, and... Form 982 Taxpayer receives a 1099-A and a 1099-C: we complete a... Cap Gn Wkt, which flows to an 8949 and the Sch D, and... Form 982... NOTE: If 1099-A and 1099-C are received in different tax years, the Cap Gn Wkt, 8849, and Sch D are done in TY 1 and Form 982 is done in TY 2… • Buyer renegotiates a mortgage, stays in the home, and receives a 1099-C: we complete a Form 982 27 Non-business credit card debt cancellation... Taxpayer receives a 1099-C from a credit card company or bank... • Debt canceled is shown in Box 2... • Canceled debt is generally considered income and is reported on the 1040, line 21, Other income, UNLESS the taxpayer was in bankruptcy or insolvent (i.e., the taxpayer’s liabilities exceeded assets) immediately before the debt was canceled... • If the taxpayer was in bankruptcy or insolvent immediately before the debt was canceled, all or part of the canceled debt may be excludable from income... • Cases involving bankruptcy or insolvency are OUT OF SCOPE... • Need to ask taxpayer if they were in bankruptcy or might have been insolvent immediately before the debt was canceled; if “yes” or “not sure,” we must refer the client to a paid preparer 28 Non-business credit card debt cancellation... Fred runs up $15,000 in credit card debt and can’t pay... He works out a deal with the credit card company to settle for $10,000, and the rest of the debt is canceled... Fred was solvent immediately before the debt was canceled... Fred receives a 1099-C from the creditor which looks like this... 5/5/2013 Bank of America 5,000.00 13 Credit card debt Fred Smith 123 Oak Street X Edgewood, MD 21040 Consequence is $5,000 of taxable income which is reported on the 1040, line 21, Other income, as CANCELLED DEBT 29 30
