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Rental Property Short Sale Tax Consequences

Discussion in 'Investment Property Loans' started by CaliforniaDreamin, Dec 30, 2008.

  1. CaliforniaDreamin

    CaliforniaDreamin LoanSafe Member

    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!
  2. Ron1234

    Ron1234 LoanSafe Member

    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.
  3. ArizonaStumped

    ArizonaStumped LoanSafe Member

    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!
  4. faith

    faith LoanSafe Member



    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,
  5. faith

    faith LoanSafe Member

    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
  6. nogero1

    nogero1 LoanSafe Member

    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?
  7. caybua

    caybua LoanSafe Member

    i have the exact same question - i have a non-recourse investment property that is $150k underwater, losing $$$ every month and would like to move on, but need to make sure i won't be charged with $150k of CoD income tax. if non-recourse means the property is used as collateral and they can't run after me for the loan, there shouldn't be any CoD income that can be imposed on me. is this correct? can any CPA/tax expert please answer this question once and for all?
    also for investment property, are we not able to claim capital loss for both foreclosure and short sale, or can we claim loss only on a short sale?
    i am willing to pay for these answers. really want to move on from this. i have consulted a few lawyers but they didn't seem to know for sure.
  8. vegasunderwater

    vegasunderwater LoanSafe Member

    Once again, there is a very cut and dried solution to what everyone makes out to be a complex issue regarding CODI (cancellation of debt income):

    CODI is not includable as income on the tax return if at the time the debt was cancelled the borrower was INSOLVENT.

    INSOLVENT = *liabilities exceed assets. You can't be solvent and get away with a short sale unless you lied to the lender about assets and/or liabilities. In other words, I don't know anyone who's short selling that isn't insolvent!

    *IRS has specific guidelines in order to "qualify" as to being insolvent.
  9. caybua

    caybua LoanSafe Member

    not everyone is insolvent. i have some equity in my primary residence, some 401k, and my car, for example. barely solvent/insolvent, and i wouldnt sell them all to pay for this under water property, would you? and when you're barely insolvent, you can only get away with the amount for which you are insolvent, which is not very much.
    however after some research, i believe that, if it is a non-recourse loan (in the case of investment/rental) then the house is being used as colateral and i am not personally liable for any debt, or CoD, therefore no CoD income tax. this is a very important point that needs to be confirmed by a professional.
    also from what i found, capital loss (such as down payment, 20% in my case) is not tax deductible.
  10. caybua

    caybua LoanSafe Member

    i've done some extensive research, i'm pretty sure these answers are correct:
    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?
    No for non-recourse property, if you use purchase-money to buy property, capital gain/loss = mortgage debt - purchased price + depreciation. say you bought the house for $350k, depreciation $5k/yr for 5 years= $25k, then:
    capital gain/loss = 270 - 350 + 25 = -$55k or a non-deductible loss of $55k (for investment property). if it were income property, then it would be deductible.
    for recourse property you'd have cancellation of debt $70k


    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?"
    see above.
  11. TomEason

    TomEason LoanSafe Guide Staff Member

    Here's the link to a comprehensive article by a CPA entitled "Tax Consequences of a Short Sale of Real Estate vs. Foreclosure." It will answer many members' questions on income tax ramifications of the various dispositions. Real Estate Short Sale vs. Foreclosure Tax Consequences
  12. MikeQ

    MikeQ LoanSafe Member

    That article was very helpful; thanks.

    I've done a ton of online research and seen all three different answers in regards to non-recourse loan investment property (you pay taxes on debt relief regardless, you never pay taxes on it, you pay taxes with short-sale but not foreclosure).

    <O:p</O:pAt least the "Real Estate Short Sale vs. Foreclosure Tax Consequences" author believes that you will never have to pay taxes on debt relief for a non-recourse loan, whether foreclosed upon or short-sold. Hope he is right! I'd hate to end up with a bunch of avoidable taxes by agreeing to a short-sale vs. just letting it foreclose.


    By the way, my CPA says no tax consequences, but there is so much contradictory info, out there I want to be sure.<!-- google_ad_section_end -->

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