Short-Sale on Rental with Personal Use

[jasdlm]

Client purchased a house in CA for Client's disabled brother to live in thinking it was a decent investment. Brother paid $500/mo rent . . . cost for house monthly was around $1,600. Claimed income on Schedule E - personal use, so majority of RE tax and Mortgage interest flowed through to Schedule A, no depreciation or other expenses - paid tax on part of rent income (based on personal use calculation).

Client paid $285,000 for house. Market tanked. Brother died, and client Sold the house in a short-sale for $75,000 with $127,000 owed to the mortage company. Non-recourse State. (BAD investment.)

Client received a 1099-C for $60,000. Client is not insolvent. I think that the $60,000 is not taxable because since CA is a non-recourse State - no COD. When I calculate the gain/loss on the foreclosure, I think client has a nondeductible loss because basis greater than the amount of the debt immediately preceding the discharge.

I have read multiple IRS pubs and instructions. I think I should report the foreclosure on Schedule D. However, I no the 1099C is going to generate a CP2000 without a 982. In reading the instructions and studying the form, I don't see how I can use the 982 because none of those exclusions apply.

Am I way off track here? Appreciate any help anyone can give.

Thanks.

[jainen]

>>not taxable because since CA is a non-recourse State<<

Well, maybe for a principal residence, which this wasn't. Non-deductible personal loss PLUS taxable COD--doesn't bother me a bit because this guy could afford to pay what he promised but just flaked out instead.

[jasdlm]

Thanks, Jainen. Just to clarify . . . it is recourse because it wasn't a personal residence? I actually wondered about that when he started the negotiation and asked him the same. He consulted an attorney (not me) and was told it was still non-recourse.

Thanks so much for your help!

[jainen]

>>was told it was still non-recourse<<

Presumably the lawyer derived that knowledge from the loan documents, since the special law about a residence doesn't apply. Did the lender check Box 5 of the 1099-C?

[jasdlm]

Yes, it is. I thought about that, but I read several different places that the multi-state lenders check that box automatically without checking to see if the Statei s a non-recoure State. This makes complete sense to me; I just wish I could find something to show my client that specifically outlines why this is taxable when the attorney (and the client's own reearch) tells him it shouldn't be. I'm sorry to be thick, but it is taxable because it is a recourse loan because the home was not the client's primary residence, and therefore COD income rather than the gain/loss on a foreclosure analysis. Correct?

Thanks again, Jainen. I really appreciate it.

[jainen]

>>it is a recourse loan because the home was not the client's primary residence<<

No, it is a NON-recourse loan because that's what the client told you after seeking legal counsel on the matter. If you think that it "appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete" [in the words of Circular 230], you should ask to see the loan documents. If the client says the attorney does not have a copy, then he's stuck with what the 1099 reports.

[joanmcq]

Was the property refinanced at any point? Have a HELOC? Either of these don't fall under the non-recourse rules.

[jasdlm]

No refinance and no HELOC. Just the 'rental/personal use' issue.