foreclosure and home equity loan

[carolevan]

Taxpayer's home was foreclosed. Both the primary mortgage loan and the home equity loan were canceled - each about $100,000. Home equity loan was used for living expenses last 3 years as taxpayer lost his job.

As I understand it, to avoid paying taxes on the cancellation of the home equity loan, the taxpayer must be insolvent (bankruptcy was not filed). Insolvency is determined immediately before the cancellation. Does this mean the FMV of the home must be taken into account as an asset? The 2 loans were for less than the FMV, so if the home is considered as an asset, the taxpayer was not insolvent. Now that his home has been foreclosed, his liabilities are greater than his assets. Basically he has nothing, and I'm trying to figure out a way for him to avoid taxes on the $100,000.

Thanks for any suggestions.

[mwcpa]

all assets are included in the computation of solvency... including all cash, all real property, small business interest, publicly traded securities, all retirement and annuity plans, etc., etc.

[carolevan]

The bank said the FMV of the home was $600,000.
The bank sold the home for $265,000.
Can the $265,000 figure be used in determining the value of the assets?

[cpadvisor]

I'd use the FMV.

If the bank says it is worth $2,000,000 that doesn't make the FMV $2,000,000 if they sell it a week later for 200,000.

[mwcpa]

from IRS.gov

"Borrowers whose debt is reduced or eliminated receive a year-end statement (Form 1099-C) from their lender. By law, this form must show the amount of debt forgiven and the fair market value of property given up through foreclosure. Though the winning bid at a foreclosure auction is normally a property’s fair market value, it may not necessarily reflect its true value in some cases."

"I don’t agree with the information on the Form 1099-C. What should I do?

Contact the lender. The lender should issue a corrected form if the information is determined to be incorrect. Retain all records related to the purchase of your home and all related debt."

I suggest you get an appraisal so you can contest the disclosure on the 1099 if you feel it is wrong... spending 2-3-400 to save thousands in tax is probably well worth it.

and

"I lost my home through foreclosure. Are there tax consequences?

There are two possible consequences you must consider:

Taxable cancellation of debt income.(Note: As stated above, cancellation of debt income is not taxable in the case of non-recourse loans.)
A reportable gain from the disposition of the home (because foreclosures are treated like sales for tax purposes).(Note: Often some or all of the gain from the sale of a personal residence qualifies for exclusion from income.)
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."