A lot of you are losing your homes and your investment real estate. A lot of you have mortgages on that real estate that exceeds your cost of the real estate. In that case, you probably have a mortgage on you real estate which exceeds its basis.
There's a trap. It adds insult to injury. Not only do you lose your property, not only is your credit impaired, not only is your self-respect and your relationships with people sometimes impaired; because us guys judge our value as humans in large part on our ability to produce income and make money and keep money.
Well, I want to warn you about a little known tax trap that you become very aware of if you're losing real estate. Bottomline, if your mortgage exceeds your basis, you will have a taxable event when your property is lost or sold in a foreclosure.
The amount of the gain will be the difference between the mortgage and the basis on the real estate; and the only exception to this is if you are insolvent at the time of the foreclosure, both before and after, if you can't meet your reasonably anticipated debts and pay your bills. If you're completely insolvent and can prove it, then there is no tax on the foreclosure.
That’s the only way out. That I know of, and that’s the only way out that I think you'll be able to possibly avail yourself of.
So, if you're about to lose a property, go talk to your tax advisor. Make sure that your not going to not only lose your property in this, your savings that you put into it; but make sure you're not hit with a substantial tax bill six months or a year later when you have to file.
Be prepared for it. Work around it and I hope that this helps you. I just wanted to warn you about a problem that sometimes jumps up and bites you.
Watch out for the Cancellation of Indebtedness Trap.
To add insult to injury, Uncle Sam may demand a hefty tax when you lose a property in foreclosure. This happens when your mortgage is in excess of your bases and you are not insolvent at the time of foreclosure.
Until the End of 2012 the Mortgage Forgiveness Debt Relief Act might also help. In general, this act generally allows taxpayers to exclude income from the discharge of debt on their principal residence subject to many exceptions.
Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, may also qualify for this relief. You need to discuss this with your Tax Return Preparer.