Rental Property Short Sale Tax Consequences

[CaliforniaDreamin]

Can anyone help me with a question about tax consequences of a short sale? I have been told by CitiMortgage that it is highly unlikely they would grant any modification on my rental property. They advised that I sell it. It would definitely be a short sale. I owe a first of ~$240K and a second of ~$30K. No idea what it would sell for, but guess around $200K.

Let's say I sell it for $200K and $70K is "forgiven." Two questions:
1) As a rental property, it does not qualify for relief under the most recent Congressional action. I then get hit with a taxable "gain" of $70K? I could likely show that I am insolvent which might get me out of the tax hit.
2) I purchased the house with an 80/10/10 for $300K. If I sell for $200K, this appears to be a $100K loss, which on a rental property could be written off. Does this loss count in any way to balance the "gain?"

And the 80/10 part of the loan was used for a purchase in California, so I believe it would be considered non-recourse. But non-recourse on investment property doesn't seem to be the same as on a primary residence.

Just looking for general guidance at this point. It is complex stuff and I will need to consult an attorney or two to get the best answers. Thanks in advance for any advice. Be well!

[Ron1234]

The loss will offset the gain:
Your tax hit will be calculated on the $70k, but differnece form the original purchase price to sell price is a (loss) which will offset the tax gain from the loan amount to the sale amount. Contact your CPA for clarity.

[ArizonaStumped]

Hi - I have a very similiar question. I have a rental property in Scottsdale, AZ that I am thinking about shortselling. It's VERY underwater and no lender will work with me to refinance and the ARM is nearly up.

Say I purchased the property for 200k, it is now worth 120k. I put 10% down (20K), so the loss on the note would be 60k. Hence 60k would be taxable as a gain. However, since it's purely a rental property, can I write off the loss of 200k - 120k = 80k? The 80k loss can then offset the 60k in "gain".

Please let me know if that's correct.

Thanks in advance for any advice!

[faith]

Originally Posted by ArizonaStumped

Hi - I have a very similiar question. I have a rental property in Scottsdale, AZ that I am thinking about shortselling. It's VERY underwater and no lender will work with me to refinance and the ARM is nearly up.

Originally Posted by ArizonaStumped

Say I purchased the property for 200k, it is now worth 120k. I put 10% down (20K), so the loss on the note would be 60k. Hence 60k would be taxable as a gain. However, since it's purely a rental property, can I write off the loss of 200k - 120k = 80k? The 80k loss can then offset the 60k in "gain".

Please let me know if that's correct.

Thanks in advance for any advice!

Hello and welcome to this forum,
I have researched the IRS websites for you so that you can find the right answers.

Figuring Gain rom Foreclosure
Use the following steps to compute the income to be reported from a foreclosure:

Step 1 - Figuring Cancellation of Debt Income (Note: For non-recourse loans, skip this section. You have no income from cancellation of debt.)

1. Enter the total amount of the debt immediately prior to the foreclosure.___________
2. Enter the fair market value of the property from Form 1099-C, box 7. ___________
3. Subtract line 2 from line 1.If less than zero, enter zero.___________

The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C. This amount is taxable unless you meet one of the exceptions in question 2. Enter it on line 21, Other Income, of your Form 1040.

Step 2 – Figuring Gain from Foreclosure

4. Enter the fair market value of the property foreclosed.For non-recourse loans, enter the amount of the debt immediately prior to the foreclosure ________
5. Enter your adjusted basis in the property.(Usually your purchase price plus the cost of any major improvements.) ____________
6. Subtract line 5 from line 4. If less than zero, enter zero.

The amount on line 6 is your gain from the foreclosure of your home. If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income. If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.


4. I lost money on the foreclosure of my home. Can I claim a loss on my tax return?
No. Losses from the sale or foreclosure of personal property are not deductible.

Here's the two links that will help you.
http://www.irs.gov/newsroom/article/0,,id=174034,00.html

http://www.irs.gov/individuals/article/0,,id=179414,00.html

Hope this helps.

God bless and take care,

[faith]

Here's more information from IRS:


Topic 414 - Rental Income and Expenses
Generally, cash or the fair market value of property you receive for the use of real estate or personal property is taxable to you as rental income. You can generally deduct expenses of renting property from your rental income. Income and expenses related to real estate rentals are usually reported on Form 1040, Schedule E (PDF). Income and expenses related to personal property rentals are reported on Form 1040 (PDF).

Most individuals operate on a cash basis, which means they count their rental income as income when it is actually or constructively received, and deduct their expenses as they are paid. If you are a cash basis taxpayer, you cannot deduct uncollected rents as an expense because you have not included those rents in income. If a tenant pays you to cancel a lease, this money is also rental income and is reported in the year you receive it. Do not include a security deposit in your income if you plan to return it to the tenant at the end of the lease. But if you keep part or all of the security deposit during any year because the tenant damaged the property or did not live up to the terms of the lease, this money is taxable income in the year this determination is made. If the security deposit is to be used as the tenant's final month's rent, you include the money as income when you receive it, rather than when you apply it to the last month's rent.
Some examples of expenses that may be deducted from your total rental income are depreciation, repairs, and operating expenses. You can recover some or all of your original expenses and improvements by using Form 4562 (PDF) (to report depreciation) beginning in the year your rental property is first placed in service, and beginning in any year you make an improvement or add furnishings. For information on depreciation, refer to Publication 946, How To Depreciate Property. Repair costs, such as materials, are usually deductible. For a discussion of the difference between repairs and improvements, refer to Publication 527, Residential Rental Property (Including Rental of Vacation Homes).

There are special rules relating to the rental of real property that you also use as your main home or your vacation home. For information on income from these rentals, or from renting at an amount less than the fair market value, refer to Topic 415, Renting Residential and Vacation Property (formerly Renting Vacation Property and Renting to Relatives).

If you do not use the rental property as a home and you are renting to make a profit, your deductible rental expenses can be more than your gross rental income, subject to certain limits. For information on these limitations, refer to Topic 425, Passive Activities – Losses and Credits.

For more information on rental income and expenses, including passive activity loss limits, refer to Publication 527.


Tax Topics - Topic 414 Rental Income and Expenses

[nogero1]

Hello all,

I'm in a similar situation as well--Investment property, purchase money 1st and 2nd's, badly underwater, considering short sell or foreclosure.
I worry about the tax consequence of forclosure/short sale as well, but this is what I keep coming back to (cut from post above from IRS)....
Figuring Gain from Foreclosure
Use the following steps to compute the income to be reported from a foreclosure:

Step 1 - Figuring Cancellation of Debt Income (Note: For non-recourse loans, skip this section. You have no income from cancellation of debt.)

For those of us in California, Oregon, Washington, etc. with non-recourse loans (assuming the lenders foreclose non-judicially) it seems to me that our loans are completely non-recourse. In that case, we have no tax liability, PERIOD!!
I keep reading that people need to make sure the are technically insolvent at the time of foreclosure or that they need to move into their rental property in order to make it their primary residence and get out of paying income received on a 1099c or hire an asset protection lawyer to hide income etc., BUT, if their loans are non-recourse then why go through the extra efforts????
Am I missing something or are people being way overly cautious? If your loans are non-recourse, there shouldn't be anything to be concerned with from a tax standpoint, right?