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February 19th, 2009 12:10 PM by David W. Welch
Marni Spence and Jill Kling with LarsonAllen LLP spoke this morning at a conference sponsored by Waterstone Mortgage (David Holbrook) and North American Title (Shelley Mannebach). This was a very helpful seminar this morning, and the number one message I have from it is "consult a tax professional!" If you are looking at a foreclosure or trying a short sale to get out from under a property, you may have a tax liability. If you are planning to try a loan modification, you may create a tax liability. If you are seeking help from a not for profit or related party to buy out your note, you may be creating a tax liability.
The good news is that if you are dealing with your principal residence you probably do not have a tax liability, unless it is over $2 million. If it is over $2 million, I hope you already have a tax expert working for you. The other good news is that in many cases the tax liability may be pushed out five years and have a five year payback period. By then, we should all be rolling in dough and anxious to pay those back taxes. If your debts have been discharged as a result of a bankruptcy, there should not be any tax liability.
If you are in a short situation or have been foreclosed on with an investment property, you will probably have some tax liability. It will based upon the difference between the fair market value of the property and the amount owed reduced by the extent of your insolvency. I hope Marni and Jill read this, and correct me if I am out of line. A quick example: Seller has assets of $500,000 and liabilities of $600,000. The insolvency is $100,000. Seller short sells an investment property for $150,000 less than the amount owed. The tax liability created is ($150,000 debt forgiven - $100,000 insovency = $50,000 taxable income). If Seller is in the 25% marginal tax bracket they are looking at a tax liability of $12,500. What I did not realize until this morning is that if the same Seller is foreclosed, instead of the short sale, they have the same tax liability.
Thanks again to Marni and Jill and also to David Holbrook with Waterstone Mortgage and Shelley Mannebach with North American Title. This was truly valuable information.
David Welch, Real Estate Optimist