Duvall & Associates, Inc.
BUSINESS ADVISOR NEWSLETTER
 

 There's a way to turn foreclosure pain into gain

- by Alan Duvall 

Published in Dayton Daily News  September 16, 2007 

“You can lose the house or lose the lease...These ain’t good games we’re playing.”  Bon Jovi 

Using complex terminology, the U.S. is experiencing a “sub-prime debt” crisis.  In laymen terms, ordinary folks are losing their homes. 

Enticed by the allure of (initially) low adjustable rate mortgages, homeowners are now besieged by the costs of escalating interest rates.  Such budgetary pressures applied against fixed incomes have forced many to simply hand their real estate keys back to lending institutions. 

Unfortunately, the pain may not end there.  In the tax world, a foreclosure of property is analogous to a sale – the proceeds being relief of a mortgage obligation as evidenced by receipt of a Form 1099-A.  Surprisingly, a foreclosure may even result in a taxable gain to the victim. 

To illustrate, assume a building originally purchased for $100,000 is saddled with a refinanced mortgage of $150,000 - possible due to appreciation.  Upon foreclosure, the owner may have a $50,000 gain since mortgage relief equates to sales proceeds. 

Fortunately, residential homeowners may avail themselves of the $250,000/$500,000 home sale exclusion for shelter from tax.  But owners of rental or business properties have no such tax amnesty, unless they can avail themselves of a statutory “insolvency exception”.   

Losses from foreclosures (where property cost exceeds mortgage) generate opposite conclusions.  Business and rental owners may deduct such losses whereas homeowners are not so blessed.   

To maneuver into position to deduct foreclosure losses, homeowners could convert personal residences into business or rental properties prior to key transfer.  The success of such a conversion is based upon factual circumstances, and is often dependent upon receipt of actual rental monies prior to foreclosure.  Thus, timing of conversion is critical.  

“97 families who lost 97 farms... Rain on the Scarecrow – blood on the plow.”  Mellencamp  

Alan Duvall is a certified public accountant in Dayton.  Contact him at Alan@Duvallcpa.com.  Previous articles archived at www.duvallcpa.com.