Cancellation of debt question again!

[Tax Prep by Deb]

I have a client who allowed her son to purchase a home using her name and credit for the purchase including loan ect...

The son's name is not and never has been attached to anything except that for two years he lived in the home and made the mortgage payments ect...

In 2007 he stopped making payments and instead of foreclosure the mortgage company allowed a short sale to take place that ended up with my client receiving a 1099C showing FMV $480.000.00 and cancellation of debt $119,432.93. The home was originally purchased for $601,591.00 (this is her adjusted basis) and the short sale was in the amount of $457,728.00.

Does anyone have any suggestions on how I can reduce the taxable cancellation of debt? She is not insolvent because of a savings account her husband had left her when he passed away. The house was never treated as rental, (although had I been doing her taxes I would have suggested it)and if I simply treat it as investment property she will have a loss on the sale, however she can only use $3,000 of it each year, so therefore doing little to help her with the canceled debt.

Any help will be greatly appreciated!

[jainen]

>>if I simply treat it as investment property she will have a loss on the sale<<

Not on my desk. That was personal use by a close family member. I'll bet you can't find a single document to support investment status--certainly all the loan papers say otherwise. It was nice of her to try to help her son that way, and if he can't repay the entire debt maybe he can at least cover the tax effect.

[Tax Prep by Deb]

>>if I simply treat it as investment property she will have a loss on the sale<<

Not on my desk. That was personal use by a close family member. I'll bet you can't find a single document to support investment status--certainly all the loan papers say otherwise. It was nice of her to try to help her son that way, and if he can't repay the entire debt maybe he can at least cover the tax effect.

Jainen,

I truly respect your opinion and was hoping you would chime in. I too had misgivings about it being investment property but I was grasping for anything. So then I believe what you are telling me is that she has a non deductible loss, I simply report it on schedule D as a sale of a personal residence? She never did live in this house, not even for a day but it was purchased with the intent that at some point her son would take out his own loan and move his mom off of everything. So this being the case the entire cancelled debt of $119,432.00 is ordinary income to her?

Thanks for any response!

Deb!

[Dale in IN]

Deb:

Still trying to get this new form figured out. I have been here all along off and on just not signed in. In answer to your question go to Pub 908, page 24, middle colum, go down about 3/4 of the way. There is an exclusion for personal residence. The way I see it you have a personal loss and personal losses can not be deducted. It would be personal residence sense her son ( a relative) lived in the home. This is the way I see it.

Basis $601591.

Short Sale $457728.

Loss $143863.

Cancled Debt $119433.

Personal loss $ 24430. I am a little rusty but I think it would go to a sch D and Cancel out.

Dale

[Tax Prep by Deb]

But the way I have always understood this exclusion is that if it was her primary residence. She never lived in the home only her son did. Someone please correct me if I am wrong as this would make a substantial difference on her return!

Deb!

[jainen]

>>this exclusion is that if it was her primary residence<<

Dale's reference apparently concerns the reduction of tax attributes (such as depreciable basis). Income from cancellation of debt is a different matter. Don't accept the 1099-C at face value--banks send them routinely out of nastiness or stupidity. READ the loan docs to see if it was in fact a recourse loan. A lot of times the only reason they'll agree to the short sale is because they can't otherwise get any money at all from the borrower. In your state (California) purchase of a primary residence is always non-recourse, and dollars to donuts that 2005 purchase was written up as owner-occupied. Read the loan docs.

[Tax Prep by Deb]

Jainen,

I will do that as I have all the info in my office. This particular 1099C is for the second mortgage. When the house was purchased the mortgage companies were selling 1st and 2nd mortgages to get around the pmi, down payment, ect... From what I see the majority of the proceeds from the sale paid off the 1st mortgage and only 2,000.00 went to the second.

Do you know if second mortgages on original purchases were also non-recourse or could this, probably is, a recourse loan?

Deb!

[jainen]

>>probably is, a recourse loan?<<

Read the papers! All I know is that if I were lending money in second position (second, as in zero security unless there's something left over) I would sure want the borrower to be good for it.

So, yeah, I guess she owes an extra $40,000 state and federal, with penalty for not making estimated payments, plus her own itemized deductions are wiped out by AMT. I wonder what she'll buy her homeless son for a Christmas present.

[Jack from Ohio]

I wonder if she is adopting....

[Tax Prep by Deb]

I wonder if she is adopting....

No! I can assure you that she is not done with her son over this. There is a long story behind all of this and I have a feeling that before it is all said and done she will be through with her son. So I'm pretty sure she won't be adopting anyone.

Deb!