We had a great call last night with everyone enrolled in the ProVision School of Tax Strategy. Welcome to all those who joined us from the Business Tax Strategies course. If you aren't yet a member, of the School of Tax Strategy, look for new opportunities to join us on our monthly coaching calls via our other tax strategy products at http://www.ProVisionWealth.com/products.
We had lots of good questions last night, when our topic was Getting the Most out of Your Real Estate Tax Benefits. One of the really good questions centered around mortgage debt relief and the recently enacted Mortgage Relief Act.
The question asked was what happens in the following situation under the Act:
You purchased a property for $200,000 at the beginning of 2007 with no money down. Now, you have negotiated a short sale with the bank and a buyer for $140,000. What is the tax effect?
The answer depends on whether this is your principal residence and whether the property is now worth only $140,000 or something else. The Mortgage Relief Act ONLY APPLIES TO YOUR PRIMARY RESIDENCE. So, if this is a rental property, the Act doesn't apply to you and you have to follow the normal rules. In addition, the Act only applies if you DO NOT sell the property. The intention of the Act is to allow you to keep your property, get a reduction from the bank in your loan principal so you can avoid a foreclosure, and not tax you on the debt relief. So, if you did not sell the property but just received a $60,000 reduction of your debt AND this is your primary residence, the debt relief will not be taxable to you.
However, if you sell the residence, then you effectively sold the house for $200,000. If the debt was nonrecourse, then you are treated as selling the house for the outstanding indebtedness on the property. Since you paid $200,000, there is no gain on the sale and you won't have to pay any tax. (Even if the debt were more, you might have the personal residence exclusion of up to $250,000/$500,000 available to you.)
If the debt were recourse and the value was $140,000, you would have debt relief of $60,000. If this is your primary residence, the income from discharge of indebtedness will be excluded from your income and not taxable. But, if this is a rental property, the Act DOES NOT apply to you. So, you would have debt relief of $60,000 (taxable to you) and a capital loss (or Section 1231 loss) of $60,000. This could be a DISATROUS RESULT for some people. See your tax advisor immediately if this is your situation!!!
Another question asked concerned the calculation of the home mortgage interest deduction for debt in excess of the limit. Specifically, if you have a home equity line of credit on your house that qualifies for the additional $100,000 debt/interest deduction and you pay down some of that line during the year and then raise it back up, and even exceed the $100,000 limit at times during the year, how do you calculate the interest deduction for the year?
The answer is simply to pro rate the interest deduction as it was incurred throughout the year. This is a computation that your tax preparer should be able to do for you fairly easily with the proper information.
Keep the questions coming! I'm happy to answer them here in my blog. For more on the Mortgage Relief Act and other tax issues, please go to our many articles on our website by logging onto Wealth Strategy U at http://www.ProVisionWealth.com/wealthstrategyu.
Warmest regards,
Tom