How are investors affected by short sales and foreclosures?
August 12, 2011
Date: 24 Jan 2009
Subject: Short Sale tax consequences for investors
Here in Florida, as in many states, the majority of foreclosures/short sales, etc. are being experienced by investors vs. primary home owners. Please discuss the situation facing investors.
Thank you for your able assistance!
Date: 6 Feb 2009
Most of the information in my article about short sales and foreclosures at www.realestateinvestingtax.com/shortsale.shtml applies to both personal homeowners and investors.
Remember that vacation homes and second homes are personal assets for which losses are not deductible and they aren’t eligible for the exclusion for cancellation of debt income relating to a principal residence.
Owners of rental properties often have accumulated suspended passive activity losses that can be applied against the income from a debt cancellation with respect to the rental.
Losses from the sale of income-producing properties may be deductible as ordinary losses under Internal Revenue Code Section 1231. (The loss is reported on Form 4797.) The loss may offset cancellation of debt income. If the property isn’t income producing, the loss may be a capital loss, limited to capital gains plus $3,000.
Taxpayers other than C corporations may elect to exclude cancellation of "qualified real property business indebtedness" from taxable income. (Internal Revenue Code Sections 108(a)(1)(D) and 108(c).) This is mostly debt incurred to acquire, construct, reconstruct or substantially improve real property used in a trade or business. (Rental real estate is not considered to be used in a trade or business.) Refinanced debt up to the qualifying amount of a previous debt also qualifies. The tax basis of depreciable real property is reduced for the excluded gain. The amount excluded is limited to the adjusted basis of depreciable real property before the discharge.
Exclusions for discharges of debt in bankruptcy in a title 11 case and up to the amount of insolvency are also available for cancellations of debt relating to investment real estate. The tax basis of assets must be reduced for the excluded gain.
See IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments (for Individuals) and Form 982 and instructions for more information.
I recommend that you get professional help when preparing your income returns with a cancellation of debt.
We have more answers to frequently asked real estate tax questions! We also offer up-to-date information about new tax real estate tax developments in Michael Gray, CPA's Real Estate Tax Letter.
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