As home foreclosures remain a major problem, a tax preparer job continues to entail addressing an affected individual's consequences with the IRS. Many taxpayers fail to understand the impact of forgiven mortgage debt and capital gain reporting for a foreclosure.
A foreclosure is the same as a sale by the homeowner. Unfortunately, any loss for a foreclosed primary residence is not tax-deductible. However, a gain might escape tax. The same rules about sale of a homestead covered in a tax preparer training course apply to foreclosures. If the house was the taxpayer's primary residence for at least two out of the preceding five years, up to $250,000 of gain is excluded from taxable income. This amount rises to $500,000 for a married couple filing a joint tax return.
Determination of gain or loss for a home is the same process learned for sale of any capital assets from paid tax preparer study. The basis for the house is the original purchase price plus closing costs. Added to this is the amount spent for major improvements that increased the life of the home.
To identify the sale proceeds in tax return preparer work with foreclosures, a taxpayer will usually have a Form 1099-A from the former mortgage company. This provides the details about the foreclosure needed to calculate a gain or loss.
With a normal mortgage the lender has recourse against the debtor if a balance is owed after the house is seized. The sale amount in such a case is the lower of the property's fair market value or the amount of outstanding debt at the time of foreclosure less any recourse balance for which the borrower is still personally liable. A non-recourse mortgage only allows the lender to foreclose on the house and not pursue any further action against the borrower. For these mortgages, the sale amount realized is simply the mortgage balance upon foreclosure.
However, in many cases, a mortgage lender simply writes off any debt balance remaining after seizing the house instead of pursuing recourse against the borrower. This creates additional tax preparer duties to address the forgiven loan amount. Lenders report cancelled debt on Form 1099-C. This is reportable income for the taxpayer with certain exceptions.
Forgiven debt on a primary residence is not-taxed when the amount is less than $2,000,000. The figure is $1,000,000 for a married taxpayer filing separately. This legislation ends in 2012 unless extended. Amounts excluded from tax must comprise only borrowing to buy, build, or improve the property.
In addition, tax return preparer education covers other instances where forgiven debt is non-taxable. Cases of bankruptcy or insolvency permit exclusion of cancelled debt from taxable income. A bankruptcy situation requires specific discharge of the indebtedness by the court. Insolvency claims necessitate proof by filing a form with the tax return.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.