I have a question. If a person loses his personal residence plus a rental home in foreclosure, what needs to be done tax wise for that year? Do you recognize a loss on the disposal of the rental and do you have to recapture depreciation, etc? I don't believe there will be any special tax treatment for the personal residence other than partial expenses, i.e. property tax, interest deduction, etc. Is that correct?
Thanks in advance for your help.
Recognition of "cancellation of debt" income means that there may be a gain.
Accounting equations:
Assets - Liabilities = net worth.
Change in net worth = income - expenses.
Just from the equations (without applying tax law), when a foreclosure happens that takes an asset that is less than the owed liability, the change to net worth that results is income to the debtor.
A foreclosure is treated like a sale. Your "sales price" for a non-recourse loan is the amount of debt canceled, for a recourse loan, it is amount of debt canceled limited by FMV of the property. You calculate gain or loss on the sale using your adjusted basis, just like any other sale, so it quite possible to have a gain on the sale even if you also have cancellation of debt (COD) income.
On the personal residence, you might qualify for excluding COD income under the Mortgage Forgiveness Debt Relief Act of 2007.
COD income does not include amounts that would have been deductible had they been paid, such as qualified mortgage interest.
-Mark Bole
Thanks for the replies.
What would happen if part of the loan to buy the Rental house was taken on the principal residence and part taken on the Rental house? In order to figure out the total debt on the Rental, would this be restricted to the loan on the Rental only or would the loan taken on the principal residence for the Rental be added as well?
Thanks again.
Yes. Normally you don't "figure out the total debt", you get information documents such as 1099-C or 1099-A that report it for you.
or would the loan taken on
What you did with the loan proceeds from the primary residence is irrelevant as far as foreclosure goes. A foreclosure on your primary residence would not be treated as a sale of your rental, and vice versa.
-Mark Bole
Thanks for the replies.
I did some reading on the IRS website as well. One more question - Cancellation of Debt Income is not taxable if loan was a non-recourse loan for purchase of a personal residence. Would this be true for purchase of a Rental property as well or would a cancellation of debt income be taxable for a Rental property with a non-recourse loan?
Also, I understand that unlike for personal residence, gain on sale due to foreclosure of a rental property does not have a $250,000 exclusion if the requirement of 2 out of 5 years as a personal residence is not met. So gain would be taxable. Is this correct?
Thanks again.
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