Spoke with attorney...have couple questions.

[swhite005hb]

We live in California and have 80/20 loan with no refinance. We spoke with a real estate attorney who confirmed that we are protected from a deficiency judgement based on both loans being purchase money.

He mentioned that although we are protected Federally (IRS), we may be susceptible to California penalty (Franchise Tax Board). It was my understanding that the California Mortgage Debt Forgiveness Act was extended through 2012 and would protect us Federally and State. Am I correct?

Also, we currently have a loan through Wells Fargo that is automatically withdrawn from our checking account each month. This allowed us to get a discount on the interest rate. When we stop making payments, would it be easier to call Wells Fargo and tell them to stop the automatic withdrawals, or go into our bank branch and change our checking account number? Would Wells Fargo dispute the request if we called?

Thanks!

[Jumbo101]

If the francise tax can happen what would your tax bill be? I thought California was not charging, I will have to ask my tax guy again.

[KT in CA]

Nope. California has not extended theirs so far past 2008. So if your is a 2009 taxable event, so far their is no CA relief. Fingers are crossed but the way the economy is now, I wouldn't hold your breath. I'm hoping they extend it. How big your tax bill is is anyone's guess, but is probably taxed as ordinary income and in pretty much the highest tax bracket. I'm sure the FTB will allow people to set up payments. Most of us don't have the cash to pay the tax bill or we wouldn't be in this mess in the first place.

[Jumbo101]

So If you walk away in California, you do not owe federal , but you will be taxed say 200K by the franchise tax board? If so why are we not hearing more stories of ,I was going to walk away but the franchise tax board will get me?

[Jumbo101]

Foreclosures and the next wave: taxes due on canceled debt

[Jumbo101]

So the way around this is BK. Or hope for a tax change.

[KT in CA]

Some people like me (who refinanced and pulled cash out) will owe federal unless some or all of it can be gotten rid of through insolvency, which is what we are hoping for. As far as why we aren't hearing stories I would guess is because it hasn't happened yet. The filings for 2008 are happening now, and people are protected. It will be this time next year when the crap will hit the fan and people will realize they aren't protected.

[Jumbo101]

So do they count it when the foreclosure is complete? What if you stopped paying in 2008 but they didnt get to it untill 2009. I assume it's a 2009 event.

[jberry]

It will be 2009 since that is when the foreclosure completed.

Juls

[LeavingAZ]

It's when the trustee sale happens, I believe.

[swhite005hb]

Does anyone know how soon the State Bill will be up for review again? I know there are some pushing for the Mortgage Forgiveness Act to be extended through 2009. Currently the Act is extended through 2009 federally. Are there other states besides California that could potentially tax for foreclosure loss?

Everytime we think we make up our mind to foreclose...something like this comes about!!

[Jumbo101]

Agreed swhite. I think I have a grasp on this and then I always figure something else out that makes me question is it worth it.

For anyone who is interested the senators that got the original tax bill passed in California are
Lou Correa from District 34
Michael Machado District 5

We should be contacting their offices and asking them to again amend the state tax laws.

[swhite005hb]

Here's a thought...
I assume California has not extended the Mortgage Debt Relief Act in an attempt to slow foreclosures. Sadly, most people in danger of foreclosure are too deep to climb out. If California begins to tax those that foreclose in 2009, it will force many to claim bankruptcy. Bankruptcy will not only eliminate the state tax debt, but also credit card debt, personal loans, etc. These very well may be payments that people had been making. This will put the California economy into a worse position then if they would just forgive the mortgage debt. Any thoughts?

[swhite005hb]

This is from the FTB website and explains the situations we are discussing...


Someone please encode this for me to understand:

" In California, purchase money mortgages, which are mortgages where the borrowed funds are used to purchase the house, are generally treated as non-recourse debt. If the bank forecloses on a non-recourse mortgage, then the homeowner is treated as having sold the home for the amount of the outstanding debt. The difference between the outstanding debt and the homeowner's adjusted basis in the house is considered a gain or loss on the sale of the home. If the home is the taxpayer's principal residence, where they have lived for at least two of the past five years, the gain may be eligible for the gain exclusion on the sale of a principal residence. If the foreclosure results in a loss, the loss may not be taken since it resulted from the sale of a principal residence.

If the mortgage is recourse, such as a non-purchase money mortgage or a refinanced mortgage, any foreclosure may result in a gain on the sale of the house, and/or cancellation of debt income. The difference between the fair market value of the house and the homeowner's adjusted basis will result in a gain or loss on the sale of the home. To the extent the outstanding debt exceeds the fair market value of the house, the amount is treated as cancellation of debt income. Any gain on the portion treated as the sale of a personal residence may be eligible for the exclusion on the sale of a principal residence; however, as discussed above, the loss may not be taken on the sale. The portion that is treated as cancellation of debt income is taxed as ordinary income - subject to ordinary income tax rates. Your clients with canceled or forgiven mortgage debts may receive a Form 1099-C from the lender and will be expected to pay federal and state tax on the canceled amounts, at the ordinary income tax rate.

For example, if the homeowner has a non-recourse mortgage with an outstanding balance of $250,000, and has an adjusted basis of $100,000, the house has a fair market value of $200,000. If the homeowner's lender foreclosed on the mortgage, the homeowner would have taxable gain of $150,000 ($250,000 less $100,000). If the mortgage had been recourse, the homeowner would have gain on the sale of the home of $100,000 ($200,000 less $100,000), and cancellation of debt income of $50,000 ($250,000 less $200,000)."

[swhite005hb]

Am I correct? ($$$ figures are specific to my situation)....

To determine the taxable income of a non-recourse debt in a foreclosure:

Greater of Fair Market Value ($305,000) or entire outstanding debt ($463,000) MINUS adjusted basis ($463,000) = $0 in capital gains.

Therefore, no taxable income?

I purchased the property for $463K in 2005 and still owe the same because of 80/20 interest only loans.

My concern is receiving a tax bill (1099) from California...any help is appreciated!

[KT in CA]

Probably the best thing is to speak with an tax attorney or CPA about the possibilities. And as far as the federal relief, that is extended either until or through 2012 now I believe.

[Dizzle831]

KT, it seems you've done your homework on the topic so let me throw this at you to make sure i'm following you.

I'm in CA too, so if i was to foreclose on my home, i would pay CA Tax on the difference on my loan amount and for what it's sold? I was under the impression you only paid tax on everything but the purchase money for the home. ie, refi cash-out and refi costs.

I'm so far underwater i may as well be neighbors to the Titanic. I owe 419k (paid 398k) and homes right across the street of similar size are selling for 150k! If you're right i'd be paying taxes on roughly 270k on top of my income!

*Ouch*

Originally Posted by KT in CA

Probably the best thing is to speak with an tax attorney or CPA about the possibilities. And as far as the federal relief, that is extended either until or through 2012 now I believe.

[Esme56]

Hello,

I'm in California as well and am very confused by this. Does this mean that non-recourse loan foreclosures are NOT taxed or do we need the tax relief act to be renewed for that to happen?

For example: My mortgage is $300,000, the value of my home is about $125,000. Will I be taxed on $175,000? YIKES!

[The Professor]

Esme56:

Let me provide you with two examples. The first is where you buy a home for $300K. You finance it for $250K. Foreclosure results in the bank getting a maximum bid of $125K. Since this was a "purchase money loan" on your residence, it is "non-recourse" under CCP Section 580b, meaning the lender's sole recourse is to foreclose and you are not personally liable, there is no tax liability and the transaction is treated as though the bank made a bid of $250K at the foreclosure sale.

The second example is the same as the first example but the property is a commercial lot (not a residence). In this scenario, you have the potential of being personally liable for the shortfall ($250K-$125K) and so you might have to pay taxes on the $100K forgiveness of debt.

Hope that helps.......

Daniel

[stryker115]

Professor, does that mean as part of a foreclosure you're not liable for any forgiveness of debt? Does the debt forgiveness only come into play when doing a short sale or DIL? I assume this would apply in Arizona as well?

[The Professor]

stryker115 asks:

Professor, does that mean as part of a foreclosure you're not liable for any forgiveness of debt?
No. The answer I gave related to California and the Franchise Tax Board's information and the nature of purchase money non-recourse debt.

Does the debt forgiveness only come into play when doing a short sale or DIL?
No. It comes into play in foreclosures also.

I assume this would apply in Arizona as well?
It is a mistake to assume anything that has to do with taxes.

Daniel

[LeavingAZ]

I spoke with my CPA regarding the tax implications here in AZ as far as state taxes are concerned and he said that they follow the federal guidelines. Meaning we won't have to pay taxes.

[stryker115]

Thanks Professor, it's clear I didn't think about your response well enough before responding.

[KT in CA]

Dizzle, the homework I have done is looked at the IRS website and read up on the MFDRA and how it relates to refinances. The examples given by the IRS are a little confusing when it comes to refinances. I am honestly not exactly sure how the amount taxable will be calculated. We have refinanced a few times since we bought our house. I'm just going to keep doing research and find a good CPA to do my taxes next year. Like I had said earlier, we are hoping to be able to claim insolvency to do away with all or part of the 1099 amount. But we are preparing ourselves for the worst possibility.

[Jumbo101]

Ok Let me know if I have this wrong. If the loan is purchase money in California for say 500K, It forecloses and the bank sells for 300K, Since the loan is purchase money I am not on the hook for the 200K with the state.
If it was a refi loan I would be because they have not matched the federal legislation that extends forgiveness to 2012.
The state tax law is not extended to 2012 at this time but was for 2007,08 but that was for all types of loans?

The state tax does not apply to purchase money, non recourse loans, correct?