About Real Estate: Foreclosures, short sales can sometimes trigger huge income-tax bill
Most homeowners can avoid a big tax bill if their home is sold for less than they owe on it, but others aren#146;t as fortunate.
Q We were foreclosed upon last summer, and the lender sold the place for about $75,000 less than we owed. How do we deal with this when we begin filling out our 2011 tax return? One friend says the Internal Revenue Service will consider the $75,000 in forgiven debt as #147;income#148; to us and that we#146;ll have to pay taxes on the amount (even though we didn#146;t earn it), but a real estate agent I talked to says no taxes will be owed. Who is right?
A. It depends on a variety of factors, including how you handled the mortgage while you still owned the home.
It#146;s the Internal Revenue Service#146;s policy to tax forgiven debt as income, even though it doesn#146;t put any extra money in your pocket. For example, if you can#146;t fully repay the $10,000 you owe on a credit card and the creditor agrees to accept only $4,000 to pay the account off, you would owe taxes on the $6,000 that the lender forgave.
That same policy held true for mortgages until 2007, when Congress passed the Mortgage Forgiveness Debt Relief Act. The law, which covers debt forgiven in a foreclosure or short sale that occurred or will occur between 2007 and the end of 2012, relieves most homeowners from tax liability on the loan amount that the lender wipes away.
The key word here is #147;most.#148; Four basic types of owners generally don#146;t qualify for this important IRS break (or only partially qualify) and therefore must pay taxes on some or all of their mortgage forgiveness. They are:
Ÿ Homeowners who refinanced and took some extra cash out, then went on a spending spree. Until recently, it was common for homeowners to do #147;cash-out#148; refis and use their newfound dough to buy a car or boat, take a vacation or simply pay off other debt. The IRS will tax the portion of the forgiven debt that was taken out and spent, with the exception of any money used to make home improvements.
Ÿ Owners who got a home-equity loan or line of credit. As with #147;cash out#148; refis, the IRS will forgive the tax liability only if the loan money was spent to remodel.
Ÿ Vacation-home owners and investors. Forgiven debt on a vacation home will be fully taxed, unless the owner can prove that he or she used it as their primary residence for at least two of the previous five years. With a few exceptions, debt that#146;s forgiven on a rental property is fully taxable.
Ÿ Mansion owners who lost their homes. A maximum of #147;only#148; $2 million in forgiven debt mortgage is free from liability, and taxes are owed on the overage. So pity the millionaire (I#146;m writing this paragraph with a smirk) who bought a palatial estate for $50 million and recently lost it at a foreclosure sale that fetched $33 million: He#146;ll owe taxes on $15 million of the $17 million in forgiveness.
Get more information by ordering a free copy of IRS Publication No. 4681, #147;Canceled Debts, Foreclosures, Repossessions and Abandonment,#148; by calling the agency at (800) 829-3676 or by downloading it from www.irs.gov. And with so much money at stake, it#146;s imperative that you consult with an accountant or similar tax professional.
Q. How long does a tax lien stay on someone#146;s credit report?
A. A tax lien that has been paid will remain on a report for seven years after the payment was received. Unpaid tax liens stay on a report for 15 years #8212; far longer than any other item that can be found on a report, including bankruptcies and foreclosures.
Q. I own a small apartment building. Is it legal for me to demand that each tenant give me a key to his or her apartment?
A. Yes, most city or county rental ordinances allow landlords to demand a duplicate key to a tenant#146;s apartment or house.
These laws protect property owners and renters alike. For example, if there#146;s a broken water pipe or a gas leak inside an apartment unit but the tenant isn#146;t home, the duplicate key can be used to allow a repairman access to fix the problem and thus limit damage to both the dwelling and the tenant#146;s personal property.
Of course, you cannot use a duplicate key simply to enter the property without a good reason. Landlords in most communities must give a tenant at least 24 hours#146; written notice to enter in nonemergency situations, such as to conduct an inspection or replace a carpet. Call your local rent-control board or apartment association for details.
Ÿ For the booklet #147;Straight Talk About Living Trusts,#148; send $4 and a self-addressed, stamped envelope to David Myers/Trust, P.O. Box 2960, Culver City, CA 90231-2960.
© 2011, Cowles Syndicate Inc.