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Comments on Insolvency and Tax Consequences of Forgiven Debt

Discussion in 'Deed in Lieu of Foreclosure - Do You Need Help to ' started by azuw67, Apr 3, 2009.

  1. azuw67

    azuw67 LoanSafe Member

    I just made an interesting spreadsheet, and learned something kind of eye-opening, until I thought about it more deeply.

    Background: A house identical to mine is listed for sale at $235k, and not selling. So my house is worth something less than $235k. Let's say maybe $220k.

    I put together a spreadsheet containing estimates of all of my assets and liabilities, which calculates the amount by which I'm insolvent, the amount of "forgiven debt", the taxable amount of that forgiven debt, and the approximate tax I would pay. Well, what I realized was that after you hit the point of insolvency, it doesn't matter how little your house is worth - for every dollar in house value you lose, there will be a dollar of forgiven debt, but that forgiven debt won't be taxable because you will be $1 more insolvent. In my own case, I found that as long as my house is worth less than $285k, it doesn't matter HOW LITTLE it is worth: I will be looking at about $15,500 in taxes owed. That's the case if my house is foreclosed and sells for $284,000, and that's the case if my house is foreclosed and sells for $1.

    Of course when looking at the cost of walking away, you have to also account for things like 2nd loan settlement (which costs you money up front but reduces the amount of forgiven debt), but of course the best bottom-line scenario is to settle for $0 and have the entire amount be forgiven debt. (If you are in the 20% tax bracket, $1.00 given in settlement only reduces your taxes by $0.20, so I'd rather hold onto the dollar and pay the 20 cents in tax.)

    Anyway, it certainly takes some of the pressure off when it comes to looking at updated house valuation estimates, when you realize that unless your house value goes up by about 25-30% it really doesn't matter.
  2. kent302

    kent302 LoanSafe Member

    Hi azuw67, you can count me in on this approach.
    What I found is going through the numbers helps me in communication with my wife. She can see the dollar premium we are paying to live in this house every month is a lost cause.
    It basically required a miracle recovery in the housing market in the next 5 years for our case.
    BTW, the local housing market projection I used:
    Yr 1 = current price
    Yr 2 = Fall 5%
    Yr 3 : Stops falling
    Yr 4 : Rise 6%
    Yr 5 : Rise 6%

    -kent

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