Cancellation of debt- am I overthinking this?

Mortgage is fully executed and recorded. It's a win/win situation - borrowers get better rate than bank offering, mother receives more interest than she was earning in the bank. Fast forward a bit - mother dies. Mortgage becomes an asset of the Estate. Wife is executrix and sole beneficiary of mother's estate. The intent is to cancel the remaining balance on the mortgage and for husband/wife to own house "free and clear".

cancellation of debt income? (There is no 1099-C filing requirement, so the IRS might never know about it. But if it were discovered and should have been reported, there would be substantial under-reporting penalties assessed.) Does the conclusion change if the wife/executor transfers the mortgage to herself as a distribution of the Estate's assets and then cancels the mortgage since she would be both creditor and debtor?

any diffential tax effects associated with continuing monthly payments to the Estate and taking a mortgage interest deduction on the personal return while paying tax on the interest income on the Estate's income tax return.

My understanding is that as long as the estate is under the limit, this year $5.12M, there's no issue at all.

In theory, what could be messy is when the loan is significant, the estate exemption, low, and an audit would view it as an asset. I will contrive an example: Estate exemption is actually $1M. The mortgage is $500K, and the $20K/yr interest is repaid with part of the $26K/yr gift mom gives the couple. Now, mom passes. We can't ignore the $500K. If it was gift it would count against unified credit, if not, it's an asset of the estate, and if it puts the estate over $1M, we can't ignore it. /end of example.

With the exemption over $5M, there's less chance there's an issue, but no, Ira, you're not overthinking it. With how convoluted the tax code is, I'm afraid nothing is so simple that, when present here, would result in that accusation.

(disclaimer - when I begin an answer with "my understanding" it means I am not 100% of my position, and am simply offering my thoughts to prompt further discussion. It's ok if i'm mistaken, and open to why that would be the case.)

Mortgage is fully executed and recorded. It's a win/win situation - borrowers get better rate than bank offering, mother receives more interest than she was earning in the bank. Fast forward a bit - mother dies. Mortgage becomes an asset of the Estate. Wife is executrix and sole beneficiary of mother's estate. The intent is to cancel the remaining balance on the mortgage and for husband/wife to own house "free and clear".

cancellation of debt income? (There is no 1099-C filing requirement, so the IRS might never know about it. But if it were discovered and should have been reported, there would be substantial under-reporting penalties assessed.) Does the conclusion change if the wife/executor transfers the mortgage to herself as a distribution of the Estate's assets and then cancels the mortgage since she would be both creditor and debtor?

any diffential tax effects associated with continuing monthly payments to the Estate and taking a mortgage interest deduction on the personal return while paying tax on the interest income on the Estate's income tax return.

$5.12M, there's no issue at all.

exemption, low, and an audit would view it as an asset. I will contrive an example: Estate exemption is actually $1M. The mortgage is $500K, and the $20K/yr interest is repaid with part of the $26K/yr gift mom gives the couple. Now, mom passes. We can't ignore the $500K. If it was gift it would count against unified credit, if not, it's an asset of the estate, and if it puts the estate over $1M, we can't ignore it. /end of example.

you're not overthinking it. With how convoluted the tax code is, I'm afraid nothing is so simple that, when present here, would result in that accusation.

100% of my position, and am simply offering my thoughts to prompt further discussion. It's ok if i'm mistaken, and open to why that would be the case.) --

Interesting... you're taking the position that the transactions are treated as a gift/transfer through estate and not as cancellation of debt. In the case at hand, there was no use of inter vivos gifts to reduce payments due mother.

No matter how one looks at it, the mortgage is an asset of the Estate for estate tax purposes. While the Estate assets are less than the current federal exemption, the parties are all located in NJ which still uses the 2001 federal exemption limit for the NJ Estate tax calculation. There will be some NJ Estate tax due.

Ira Smilovitz

Mortgage is fully executed and recorded. It's a win/win situation - borrowers get better rate than bank offering, mother receives more interest than she was earning in the bank. Fast forward a bit - mother dies. Mortgage becomes an asset of the Estate. Wife is executrix and sole beneficiary of mother's estate. The intent is to cancel the remaining balance on the mortgage and for husband/wife to own house "free and clear".

cancellation of debt income? (There is no 1099-C filing requirement, so the IRS might never know about it. But if it were discovered and should have been reported, there would be substantial under-reporting penalties assessed.) Does the conclusion change if the wife/executor transfers the mortgage to herself as a distribution of the Estate's assets and then cancels the mortgage since she would be both creditor and debtor?

JMO. It seems cleaner in the long run to spend a little extra up front on attorney and filing fees and transfer the mortgage asset from the estate to the daughter. Then she, as mortgagee, can file a satisfaction. No COD or gift tax issues arise.

Phil Marti VITA/TCE Volunteer Clarksburg, MD

Mortgage is fully executed and recorded. It's a win/win situation - borrowers get better rate than bank offering, mother receives more interest than she was earning in the bank. Fast forward a bit - mother dies. Mortgage becomes an asset of the Estate. Wife is executrix and sole beneficiary of mother's estate. The intent is to cancel the remaining balance on the mortgage and for husband/wife to own house "free and clear".

cancellation of debt income? (There is no 1099-C filing requirement, so the IRS might never know about it. But if it were discovered and should have been reported, there would be substantial under-reporting penalties assessed.) Does the conclusion change if the wife/executor transfers the mortgage to herself as a distribution of the Estate's assets and then cancels the mortgage since she would be both creditor and debtor?

attorney and filing fees and transfer the mortgage asset from the estate to the daughter. Then she, as mortgagee, can file a satisfaction. No COD or gift tax issues arise.

Phil - I am just asking - do you agree that the mortgage value is an asset for purposes of federal and state estate tax? That was part of what I was getting at in my example.

A legitimate gift is never considered income. In this case a mother leaving a note to her daughter cancels the daughter's requirement to pay because she would be paying herself. But it is a gift born out of affection with no consideration given in return.

It would be the same for the cancellation of debt for the daughter's husband - it is a gift out of disinterested generosity based on affection and without consideration. No no cancellation of debt income under the circumstances.

___ Stu

Stu - my only issue here is the mortgage is an asset of the estate. If it's over the limit (unlikely in 2012) it needs to be addressed, no different than if the borrower were a third party.

To add: In Pub

- Page 3 --gifts are listed as a exception to COD income.

Inheritances are gift and are treated that way. The mortgage is an asset of the estate. But the cancellation of debt came about as a matter of law, because normally you can't owe money to yourself.

By the way, the note gets valued in the estate based on the market value of the note (e.g. discounted value) rather than the amount still owed on the date of death.

___ Stu

Right. It says (among other things relevant on this point),

"Generally, if a debt for which you are personally liable is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income."

If it's a gift or bequest, it's not counted as income.

___ Stu

AM UTC-4, ira smilovitz wrote: > >> Husband and wife refinance their mortgage with wife's mother as lender. Mortgage is fully executed and recorded. It's a win/win situation - borrowers get better rate than bank offering, mother receives more interest than she was earning in the bank. Fast forward a bit - mother dies. Mortgage becomes an asset of the Estate. Wife is executrix and sole beneficiary of mother's estate. The intent is to cancel the remaining balance on the mortgage and for husband/wife to own house "free and clear". >> >> If the wife cancels the mortgage in her role as executrix, is this cancellation of debt income? (There is no 1099-C filing requirement, so the IRS might never know about it. But if it were discovered and should have been reported, there would be substantial under-reporting penalties assessed.) Does the conclusion change if the wife/executor transfers the mortgage to herself as a distribution of the Est ate's assets and then cancels the mortgage since she would be both creditor and debtor? > > JMO. It seems cleaner in the long run to spend a little extra up front on attorney and filing fees and transfer the mortgage asset from the estate to the daughter. Then she, as mortgagee, can file a satisfaction. No COD or gift tax issues arise. Phil - I am just asking - do you agree that the mortgage value is an asset for purposes of federal and state estate tax? That was part of what I was getting at in my example. --

There was never any doubt in my mind that the value of the mortgage is an asset of the estate which must be included for estate tax purposes.

Ira Smilovitz

- Page 3 -- > gifts are listed as aexception to COD income. Right. It says (among other things relevant on thispoint), "Generally, if a debt for which you are personally liable is canceled orforgiven, other than as a gift or bequest, you must include the canceled amountin your income." If it's a gift or bequest, it's not counted as income. ___ Stu -- Thanks. That's exactly what I needed - the explicit exception to the general rule of cancellation of debt being income.

Ira Smilovitz

If the wife cancels the mortgage in her role as executrix, is this cancellation of debt income? (There is no 1099-C filing requirement, so the IRS might never know about it. But if it were discovered and should have been reported, there would be substantial under-reporting penalties assessed.) Does the conclusion change if the wife/executor transfers the mortgage to herself as a distribution of the Estate's assets and then cancels the mortgage since she would be both creditor and debtor?

In case it matters, this is NOT a community property state. I'm also ignoring any diffential tax effects associated with continuing monthly payments to the Estate and taking a mortgage interest deduction on the personal return while paying tax on the interest income on the Estate's income tax return. ==================== I'd say you're overthinking this.

The daughter (as executrix) should simply distribute the rights of the loan to herself (as beneficiary), thus becoming a "loan to one's self" and as such, a legal nullity with nothing to cancel.

The only problem that could arise: If the estate needs to collect something on the loan in order to pay estate tax. However, even that is avoided since the loan was to the executrix.

It's still debt cancellation, and would be taxable if it weren't a gift. If an agreement to transfer to loan to the debtor by will were included in a commercial, arms-length transaction, I'd think there would still be cancellation of debt income even though it would be transformed into a loan to ones-self.

If there are insufficient funds in the estate to pay estate tax without liquidating estate assets, the assets are supposed to be sold to pay the tax. If that doesn't happen, the recipient would be liable for his share of the tax.

___ Stu