The following is taken (well… almost) directly from Ed McFerran, McFerran Law, P.S. (253) 284-3838 or www.mcferranlaw.com. He knows a lot of stuff.
First, you’re probably thinking to yourself… “Jen, we’re waaay past this whole recession thing. Why are you talking about debt forgiveness?Why? To this day, I get a steady stream of calls from property owners and agents with questions about short sales and foreclosures. They are fewer in number, but they are not gone.
The tide has shifted (for me, anyway.. not sure about the whole industry). Many of the questions I’m hearing are from owners of investment properties, not their personal homes anymore. Regardless, it’s stressful to deal with.. no matter what time of year. There are things you should know that people aren’t talking about. Maybe someone you care about should hear them too. Rest assured, all conversations are confidential and will go to the grave with me. (Shhh.. now, I will borrow some great pointers from Mr. McFerran.)
LET’S BE STRAIGHT ABOUT THIS “FORGIVENESS OF DEBT TAX” THING:
- It is a tax;
- It comes to us from the federal government (IRS);
- It involves anytime we have a debt owed;
- When a lender forgives that debt owed (as in a short sale or foreclosure), we have additional income of a like amount;
- That income is taxed to us at the same rate of our ordinary employment earnings;
- Every short sale will generally produce some forgiveness of debt;
- Every foreclosure will generally also produce forgiveness of debt (commonly misunderstood);
- Up until December 31st last year, most of my customers were exempt by a law that expired at the end of last year. (NOTE 12/24/15 – This should now be extended through 2015 & 2016!! One day, it will eventually expire for good.)
HOW DO WE HANDLE THIS TAX MATTER IN 2015?
- It is still a tax;
- It did not go away;
- The previous Mortgage Debt Forgiveness Relief Act did expire December 31st last year;
- We have a marvelous law still in place that provides nearly an identical outcome;
- We call it the insolvency exemption;
- It is a well-established tax law. It may require some planning ahead to be effective.
WHAT IS THIS INSOLVENCY EXEMPTION AND HOW DOES IT WORK?
- It also has been a good law for many years before the Recession;
- It is still a good law now and won’t expire;
- It helps owner occupants as well as non-owner occupants avoid taxes;
- It eliminates forgiveness of debt tax for most of my clients and reduces it for others;
- We look at the seller’s debts and assets and determine what level of assets versus liabilities (debts);
- If debts exceed assets, then no tax;
- If assets exceed debts, tax only payable to the extent of the solvency.
WHAT IS THE BIGGEST MISUNDERSTANDING REGARDING THIS RULE?
- Many parties are out there advising people to just go through foreclosure and say it is a more favorable outcome… WRONG!;
- Foreclosure will almost always produce a greater tax cost and far greater credit impairment than a short sale;control in a short sale.
- There are other options to discuss
- A seller has far more control in a short sale.
- There are other options to discuss besides short sales and foreclosures!
If someone you know is in a rough spot, relieve some of their stress this holiday season and have them call me. There are options to ease the pressure. And, there are a number of things that need to be taken into account before deciding anything… whether it is to walk away, try a short sale, payment options, bankruptcy, or maybe just suck it up and stick it out a little longer. It’s a business decision.
Either way, they need to be aware of the costs involved so they don’t get a big fat surprise from the IRS that says “you owe me!”
Strategy is half the battle. I can help. Call/text at (206) 293-1005 or email: Jen@HudsonCREG.com.