Articles Posted in Mortgage Tax Debt Relief

Did you buy a new home in Los Angeles, Whittier, Norwalk, Santa Fe Springs, Downey, Pico Rivera, Montebello, Hacienda Heights, La Habra Heights, West Covina, La Habra, Brea, Fullerton, Yorba Linda, Cerritos, La Mirada, Lakewood, Anaheim, Santa Ana, Long Beach, Compton, Torrance, Los Angeles, Pasadena, Beverly Hills, Santa Monica and throughout Los Angeles County, Orange County, Corona, San Bernardino County, Riverside County, the Inland Empire, the San Fernando Valley and the San Gabriel Valley.

If you’re a homeowner, Uncle Sam has thrown you a tax shelter that’s beyond compare. You may deduct the mortgage interest paid on your annual tax return and deduct the property taxes on your Schedule A. If you don’t currently own a home, this tax benefit is significant enough to make you look seriously at home ownership.

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Mortgage debt relief extension, tax relief for community banks, and crackdown on some executive compensation in the 2008 Economic Stabilization Act

I am writing to provide details regarding three tax provisions in the Emergency Economic Stabilization Act of 2008: which was enacted Oct. 3, 2008. Those provisions are: (1) an extension for home mortgage debt forgiveness relief, (2) tax relief for community banks that invested in Fannie Mae and Freddie Mac preferred stock, and (3) a tax crackdown on compensation and severance pay for certain financial executives. Here are the key details regarding those provisions.

Two-year extension of home mortgage debt forgiveness relief provision. The new law provides assistance to homeowners who have been caught in the current mortgage crisis and are trying to save their homes. Under 2007 tax legislation, taxpayers are generally allowed to exclude up to $2 million of mortgage debt forgiveness on their principal residence. However, this relief provision was scheduled to expire at the end of 2008. Under the new law, this debt relief provision is extended through 2012. To understand the importance of this relief provision, one needs to know that for income tax purposes, a discharge of indebtedness–that is, a forgiveness of debt–is generally treated as giving rise to income that’s includible in gross income. Under pre-2007 tax law, there were no special rules applicable to discharges of acquisition debt on the taxpayer’s principal residence. For example, assume a taxpayer who wasn’t in bankruptcy and wasn’t insolvent owned a principal residence subject to a $200,000 mortgage debt for which the taxpayer had personal liability. The creditor foreclosed and the home was sold for $180,000 in satisfaction of the debt. Under pre-2007 tax law, the debtor had $20,000 of debt discharge income. The result was the same if the creditor restructured the loan and reduced the principal amount to $180,000. In 2007 the tax laws were temporarily changed to allow taxpayers to exclude up to $2 million of mortgage debt forgiveness on their principal residence. For example, assume the same facts as in the foregoing example except that the discharge occurs in 2008. In that case the debtor has no debt discharge income when the creditor (1) restructures the loan and reduces the principal amount to $180,000 or (2) forecloses with the result that the $200,000 debt is satisfied for $180,000. However, this debt relief provision was scheduled to expire at the end of 2009. The new legislation extends the provision through 2012. The relief is not extended to home equity loans.

Tax relief for community banks. Some 800 community banks had huge losses on their Fannie Mae and Freddie Mac preferred stock holdings which became worthless when the government bailed those companies out. Without a tax change, these community banks would have had capital losses on these holdings that they couldn’t utilize. The new legislation allows community bans to treat losses on their Fannie Mae and Freddie Mac preferred stock as ordinary losses that can offset ordinary income. Applying to any preferred stock that was owned on Sept. 6, 2008, or sold between Jan. 1, 2008, and Sept. 6, 2008, this provision allows banks to claim the book benefit of the loss on their tax returns, thereby reducing their need to obtain additional capital from the FDIC or investors.

Tax crackdown on compensation and severance pay for certain financial executives. Under the new law, when more than $300 million of a company’s assets are purchased by the Treasury through an auction, (1) “golden parachute” payments are banned for top executives hired while the Treasury rescue is in effect and (2) tax provisions kick in to strengthen the tax treatment of remaining executive compensation and severance packages. Specifically, the deductibility of executive compensation for companies will be cut in half from pre-Act levels, and companies will also lose deductions available under pre-Act law for excessively large severance packages. Executives receiving severance packages will continue to face a 20% excise tax on payments once they reach an excessive threshold, and that tax will be due if the executive leaves for reasons other than a standard retirement for which they are eligible–not just if the company changes hands, as in pre-Act law.

I hope this information is helpful. If you would like more details about these changes, or any other aspects of the new law, please do not hesitate to call.

Beneficial owners can deduct home mortgage interest and taxes The Tax Court held that taxpayers were entitled to deduct mortgage interest and real estate taxes they paid on property owned by their son, because they were the beneficial owners of the property.

The taxpayers resided at the property for all of 2003. During that time, title to the property was in the name of their son, as was the mortgage on the property. Their son had obtained a mortgage loan and took title to the house to procure it for the taxpayers who were unable to secure a loan because of financial difficulties. The son did not live on the property, and the taxpayers paid for all maintenance of, and taxes on, the property. Mortgage payments from 2001 until the time of the trial were made through Camrock General Engineering, Co. Camrock was the taxpayers’ company; one taxpayer was its registered agent and the other its president. After the taxpayers moved from the residence, they served as landlords; they rented the property to a tenant and performed all services related to that tenancy

The taxpayers claimed on their 2003 federal income tax return deductions for home mortgage interest and real estate taxes of $3,522 and $3,194, respectively, on the residence property. The IRS contended that because the taxpayers had no legal obligation to make the mortgage payments and did not hold title to the property, they were not entitled to deduct the mortgage payments. The Service further argued that the taxpayers did not make the mortgage payments; the payments were made by Camrock.

The taxpayers claimed that although their son had legal title to the property, they owned Camrock, and through the company, they had assumed the mortgage from the outset. The payments were made from a bank account registered to the company, of which the taxpayers were signatories. The company was not an active business in 2003, but did have a bank account, which functioned as a personal account for the taxpayers.

Section 163(a) generally allows a deduction for all interest paid or accrued within the tax year on debt. However, under Section 163(h)(1), noncorporate taxpayers generally cannot deduct personal interest. Qualified residence interest is excluded from the definition of personal interest, and the deduction of qualified residence interest is allowed under Section 163(h)(3). The court pointed out that the debt must be the taxpayer’s obligations and not an obligation of another. In Uslu, TC Memo 1997-551, the Tax Court held that when a residence was occupied exclusively by the taxpayers who made all mortgage payments, the debt may be found to rest solely on those taxpayers who were entitled to deduct the mortgage payments.

The Tax Court held that like the taxpayers in Uslu, the taxpayers in the present case were equitable and beneficial owners of the property. The court said that it was undisputed that the property was a “qualified residence” under Section 163(h)(4)(A), and thus the taxpayers were entitled to claim the mortgage interest deductions on the property. As with mortgage interest, the court has held that taxpayers who do not have legal title to property may still deduct property taxes under Section 164(a) if they establish equitable ownership of the property. Because the court found that the taxpayers were the equitable and beneficial owners of the property, the court said they were also entitled to their claimed deductions for real estate taxes.

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Foreclosure Prevention Act of 2008 S

enate passes housing stimulus bill

Mike Habib, EA

On Apr. 10, the Senate by a vote of 84 to 12 approved H.R. 3221, the “Foreclosure Prevention Act of 2008,” the Senate housing stimulus bill. Before final passage of the bill, the Senate approved an amendment offered by Senator John Ensign (R-NV) that would extend various clean energy production incentives.

Key provisions in the bill would:

    (1) Extend the net operating loss (NOL) carryback for losses incurred in tax years 2008 and 2009 from the two year carryback permitted currently to four years (back to 2004 and 2005, respectively) to aid homebuilders and other businesses hit hardest by the economic slump. Taxpayers would be given the choice of (a) electing the longer NOL carryback, or (b) claiming the larger expensing allowance and bonus first year depreciation authorized by the Economic Stimulus Act of 2008.

    (2) Modernize the tax rules for real estate investment trusts (REITs) to provide them with flexibility to reflect recent changes in real estate markets.

    (3) Allow businesses unable to benefit from bonus depreciation due to extended periods in a loss position to receive refunds of alternative minimum and research and development credits when they make investments.

    (4) Create a new standard deduction for property taxes paid by nonitemizers. The deduction, available only for tax years beginning in 2008, would be $500 for single filers and $1,000 for joint filers. This relief would not be available if the rate of tax for all residential real property taxes in the jurisdiction is increased after Apr. 2, 2008, and before Jan. 1, 2009.

    (5) Create a tax credit for taxpayers who buy foreclosed single-family homes and use them as their principal residences. The credit would be: available for the purchase of only one home; up to $7,000 of the cost of the home; claimed ratably over two tax years; and available for purchases made within a one year period beginning after the date of enactment. Eligible single-family homes would be those upon which foreclosure has been filed under state law, and that: (a) are new, previously unoccupied residences for which a building permit was issued and construction began before Sept. 1, 2007; or (b) were occupied as a residence by a mortgagor for at least one year before the foreclosure filing.

    (6) Allows victims of Hurricanes Katrina and Rita to adjust casualty loss deductions taken in addition to grant payments to cover uninsured losses caused by the hurricanes. The provision would allow the use of amended income tax returns to take into account receipt of certain hurricane-related casualty loss grants by disallowing previously taken casualty loss deductions. The provisions also would waive the deadline on the construction of GO Zone property which is eligible for bonus depreciation.

    (7) Increase the overall allocation to mortgage revenue bonds by an additional $933 million.

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Did you know that forgiven credit card debt triggered taxable income

Mike Habib, EA

A new Tax Court case illustrates how a taxpayer generally has taxable income when a credit card company agrees to accept a reduced payment in settlement of his or her account.

Background. A solvent debtor usually realizes income from the discharge of a debt. (Code Sec. 61(a)(12)) Debtors who are insolvent, in bankruptcy, or (in certain cases) farmers and noncorporate debtors whose debt is qualified real property business indebtedness do not recognize income on a cancellation of a debt. (Code Sec. 108(a)) Instead, they must reduce their loss or tax credit carryovers or the basis in their assets. (Code Sec. 108(b)) These reductions can cause the debtor’s taxes to increase in future years.

In addition, cancellations of up to $2 million of mortgage debt on an individual taxpayer’s main home in 2007 through 2009 are excluded from income, but the taxpayer’s basis in the home must be reduced. (Code Sec. 108(a)(1)(E), Code Sec. 108(h))

The amount of COD income where indebtedness from a credit card account is discharged is the difference between the entire amount due on the accountand the amount paid for the discharge. If no consideration is paid for the discharge, the amount of COD income is equal to the entire amount due on the account.

Code Sec. 108(e)(5) provides an exception to Code Sec. 61(a)(12) where the buyer of property negotiates with the seller/creditor for a discharge of all or part of the purchase money indebtedness. Commonly such a discharge reflects a decline in the value of the property. The resulting discharge of indebtedness is characterized not as taxable income but in effect as a retroactive reduction of the purchase price.

Facts. Ancil Payne used his credit card with MBNA America Bank to pay hospital bills and receive cash advances during periods of unemployment. By Apr. 26, 2004, he accumulated $21,407 of debt on the card. Later in 2004, Mr. Payne and MBNA entered into an agreement whereby MBNA agreed to accept $4,592 as a full settlement of the account balance of $21,270, payable in installments over 4 months. Mr. Payne made the necessary payments, and MBNA issued him a Form 1099-C, Cancellation of Debt, reporting $16,678 of discharge of debt income.

On his 2004 joint return, he and his wife did not report any debt discharge income. Instead, they attached a statement to their return which disclosed that they received a Form 1099-C from MBNA that reported discharge of debt income of $16,678. The statement also explained that they believed the amount disclosed on the Form 1099-C was not subject to income tax.

IRS determined a deficiency for the Paynes’ failure to report debt discharge income. The couple petitioned the Tax Court for a redetermination of the deficiency.

Failed argument. Before the Tax Court, the Paynes contended that their settlement with MBNA did not result in the discharge of indebtedness but was rather a retroactive reduction of the rate of interest charged by MBNA and thus a reduction of the “purchase price” of the loans under Code Sec. 108(e)(5). The Paynes argued that the lending of money in a generic credit card transaction constitutes the sale of property under Code Sec. 108(e)(5).

The Tax Court said that the Paynes were mistaken. It stressed that MBNA effectively lent them money to be used for health care costs and general living expenses. The only relationship between the parties was that of debtor and creditor, and thus the Tax Court held that Code Sec. 108(e)(5) did not apply.

    Observation: Many individuals may be in a similar situation of needing a credit card workout. While getting the bank to agree to a big reduction in the debt is obviously a plus, as shown in this case, the debt discharge can trigger income. For some, however, the debt discharge income may not have practical tax consequences. For example, if the discharge occurs during a period of unemployment when the individual has little or no income from other sources, the individual effectively may owe little or no tax on it. While there probably is not much latitude to time a settlement, to the extent possible, individuals should try to arrange it during periods when the income from the discharge won’t have severe tax consequences.

Investors suffered theft loss in connection with company that issued sub-prime loans

Mike Habib, EA

A Chief Counsel Advice (CCA) has concluded that a theft occurred in connection with investors’ losses on loans to a company engaged in writing sub-prime loans. However, it determined that whether and when a theft occurred for any particular investor, and what losses resulted from the theft, was a question of fact since the company had been engaged in legitimate business for many years before the theft occurred.

Facts. Taxpayers (investors) invested in notes issued by X, which had been in business as a lender for many years and later expanded into writing sub-prime mortgage loans. X sold unsecured and uninsured notes exclusively to State residents because the company wished to avoid being subject to federal securities regulations. X was a legitimate business that offered returns which were greater than those typically offered to bank depositors, but were commensurate with returns available from corporate bonds.

Later, X was acquired by Y, which was primarily engaged in the business of mortgage lending. X continued to exist, but its direct lending activities were curtailed. Most of the proceeds of X’s borrowings were loaned to Y. The market for high-risk mortgages subsequently crashed, and Y suffered significant losses. Y’s business deteriorated as the losses mounted, and it was only able to stay in business by using the cash X generated from the sale of its notes to the public for operating capital. When X distributed annual prospectuses to its investors (as required by State securities law), they represented that X continued to conduct substantial business of its own and showed X to be solvent by virtue of its loans to Y. Y’s financial condition wasn’t disclosed. Further, X and Y officers and directors made public statements misrepresenting X’s financial condition.

In a few years, Y owed more to X’s investors than the company was worth. The losses forced Y and its subsidiaries to cease operations and file for bankruptcy. Under a liquidation plan approved by the Bankruptcy Court, investors received a payout. Thousands of investors affected by the bankruptcy suffered losses. Several people associated with X were convicted of securities violations under State law. X’s president pled guilty to a number of counts of securities fraud, while another insider was convicted of a number of counts of securities fraud in connection with X. One officer was indicted on criminal charges, including obtaining signature or property by false pretenses and breach of trust with fraudulent intent.

Background. A taxpayer can deduct a loss suffered during the tax year and not compensated for by insurance or otherwise. For an individual, a loss deduction is limited to losses incurred in a trade or business, or a transaction entered into for profit, or arising from fire, storm, shipwreck, or other casualty or from theft. ( Code Sec. 165(c) ) IRS broadly defines “theft” for purposes of Code Sec. 165(c)(3) so that a taxpayer need only prove that his loss resulted from a taking of property that is illegal under the law of the state where it occurred and that the taking was done with criminal intent. (Rev Rul 72-112, 1972-1 CB 60)

A loss that is the direct result of fraud or theft is deductible under Code Sec. 165 , even though the theft is accomplished through a purported borrowing or offer to sell a security. (Vietzke, 37 TC 504 (1961) acq., 1962-1 CB 4) IRS ruled that where a taxpayer was induced to lend money to a corporation by fraudulent financial statements that didn’t reflect large liabilities which made the corporation insolvent, the taxpayer was entitled to a theft loss deduction. The money was obtained by false representations constituting a misdemeanor under state law. IRS reached this conclusion based on the taxpayer’s reliance on the misrepresentations and the specific intent to separate the taxpayer from his money through fraud. (Rev Rul 71-381, 1971-2 CB 126) However, the worthlessness of valid debt is not a theft loss. (Spring City Foundry Co. v. Comm. 13 AFTR 1164 , 292 U.S. 182)

Theft found. In X and Y’s situation, the CCA concluded that the facts established that a theft had occurred. While IRS initially based its assessment on X and Y being in a legitimate business and suffering losses in the ordinary course of that business, the CCA reasoned that later facts revealed the nature of the insider’s fraudulent statements: various insiders’ statements downplayed X’s true financial difficulties; financial statements issued to the investors presented X as a solvent enterprise; the statements didn’t contain Y’s balance sheet (which would have shown its insolvency); and X’s financial statements treated the loans to Y as assets at face value. In addition the financial statements also indicate that X was engaged in the mortgage business on its own behalf, while, in fact, after its acquisition by Y, it existed only to raise capital for Y. Further, there were securities violations cases and an insider was indicted on criminal charges requiring a misappropriation of property as an element of the crime.

The CCA noted that not every securities violation is a theft of property, and a loss or taking of property is generally not a required element of securities fraud. Thus, losses on open market transactions are not theft losses even if the market values of the securities were inflated by insiders’ fraud. However, in this case, criminal charges were brought against at least one Y’s officers.

Deductible loss. The CCA, however, concluded that it remained a question of fact whether and when a theft occurred with regard to any particular investor, and what losses resulted from theft. The CCA found that a determination had to be made as to whether, or at what point, loans to X no longer represented bona fide debti.e., both parties intending that the money advanced be repaid. X had conducted substantial legitimate business for many years, issuing notes and repaying debts as they came due. It was a question of fact when a loan to X was no longer bona fide debt, but a theft, or when the officers’ conduct with regard to the money entrusted to X by the investors amounted to an arrogation of those funds with the intent to deprive the investors of their enjoyment.

To the extent that IRS determines that an investor’s losses were the result of the worthlessness of a security under Code Sec. 165(g), the CCA concluded that the loss occurred when the security was wholly worthless. (Reg. § 1.165-5(c)) To the extent that IRS determined an investor’s loss resulted from theft, the loss was treated as sustained during the tax year in which the taxpayer discovered the loss. (Code Sec. 165(e), Reg. § 1.165-8) Where there is a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no part of the loss for which reimbursement may be received is sustained under Code Sec. 165 until the tax year in which it can be ascertained with reasonable certainty.

The CCA also concluded that the open transaction doctrine (treating payments to taxpayers as a return of capital and not ordinary income) was only proper for amounts actually or constructively received after the fraud was discovered. Thus, payments made by X in the year the fraud was discovered weren’t income unless the taxpayer’s basis was exceeded. While returns may be amended if an amount was reported as income but wasn’t in fact actually or constructively received, the open transaction doctrine should not be applied retroactively. The proper remedy for taxpayers who have suffered a loss is a deduction.

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Mortgage Tax Debt Relief, AMT Relief – why you need professional tax advice

AMT relief. In general terms, to find out if you owe alternative minimum tax (AMT), you start with regular taxable income, modify it with various adjustments and preferences (such as add-backs for property and income tax deductions and dependency exemptions), and then subtract an exemption amount (which phases out at higher levels of income). The result is multiplied by an AMT tax rate of 26% or 28% to arrive at the tentative minimum tax. You pay the AMT only if the tentative minimum tax exceeds your regular tax bill..

Although it was originally enacted to make sure that wealthy individuals did not escape paying taxes, the AMT has wound up ensnaring many middle-income taxpayers. One reason is that many of the tax figures (such as the tax brackets, standard deductions, and personal exemptions) used to arrive at your regular tax bill are adjusted for inflation, but the tax figures used to arrive at the AMT are not.

For 2007 only, a new law provides some relief. It increases the maximum AMT exemption amount over its 2006 level by $3,700 for married taxpayers filing joint returns, and by $1,850 for unmarried individuals and married persons filing separately. However, after 2007, the maximum AMT exemption amount will drop precipitously to where it was in the year 2000 unless Congress provides another fix.

Another provision in the new law provides AMT relief for those individuals claiming certain “nonrefundable” personal tax credits (such as the credit for dependent care and the Scholarship and Lifetime Learning credits). For 2007, these credits may offset an individual’s regular tax and AMT. After 2007, unless Congress acts, these credits will be allowed only to the extent that an individual has regular income tax liability in excess of the tentative minimum tax, which has the effect of disallowing these credits against AMT.

Another new law also liberalized the AMT refundable credit amount that was first enacted in 2006 to help taxpayers who were stung by the AMT as a result of exercising incentive stock options. The change is highly technical but the essence of it is that eligible individuals may now claim this credit more rapidly (i.e., over fewer years) than would have been the case without the change.

Forgiven mortgage debt tax relief. Addressing the subprime lending crisis, another late 2007 law provides tax relief for homeowners whose mortgage debt is forgiven. Prior to the enactment of this law, a homeowner could be taxed on the amount of forgiven mortgage debt. For example, before this law, an individual with a $200,000 mortgage whose lender foreclosed on the home and sold it for $180,000 would have had to report $20,000 of income from the forgiven debt. The result would have been the same if the lender restructured the loan and reduced the principal amount to $180,000. Under the new law, a taxpayer does not have to pay federal income tax on up to $2 million of debt forgiven for a qualifying loan secured by a qualified principal residence (e.g., one to buy or renovate a residence). The change applies to debts discharged from Jan. 1, 2007 to Dec. 31, 2009.

Mortgage insurance deduction extended for 3 years. Mortgage insurance premiums will continue to be deductible after 2007, thanks to another relief provision for homeowners. Originally, this deduction was available only for 2007. It now applies through 2010. Basically, it allows taxpayers to treat amounts paid during the year for qualified mortgage insurance as home mortgage interestand thus deductible in most instances. The special rule for home mortgage interest is phased out at higher levels of adjusted gross income (AGI). The insurance must be in connection with home acquisition debt, the insurance contract must have been issued after 2006, and the taxpayer must pay the premiums for coverage in effect during the year.

Homesale exclusion liberalized for surviving spouse. A qualifying taxpayer may exclude up to $250,000 ($500,000 for joint return filers) of gain from the sale or exchange of property that the taxpayer has owned and used as his or her principal residence. Married taxpayers filing jointly for the year of sale may exclude up to $500,000 of home-sale gain if (1) either spouse owned the home for at least 2 of the 5 years before the sale; (2) both spouses used the home as a principal residence for at least 2 of the 5 years before the sale; and (3) neither spouse is ineligible for the full exclusion because of the once-every-2-year limit on the exclusion.

Before the late 2007 law changes, the up-to-$500,000 exclusion was available only if a husband and wife filed a joint return for the year of sale. Thus, if the home was sold in a year after the year of a spouse’s deathit allows a surviving spouse to qualify for the up-to-$500,000 exclusion if the sale occurs not later than 2 years after the spouse’s death, provided the requirements for the $500,000 exclusion were met immediately before the spouse’s death and the survivor has not remarried as of the date of the sale.

Tax relief for volunteer responders. Tax relief is on the way for volunteer firefighters and emergency medical responders, thanks to a little publicized provision in one of the late-breaking 2007 tax laws. It creates an income tax exclusion for qualified state or local tax benefits (such as reduction or rebate of state or local income or property tax) and qualified reimbursement payments (up to $360 a year) granted to members of qualified volunteer emergency response organizations (e.g., state or local organizations whose members provide volunteer firefighting or emergency medical services (EMS)). The new exclusion applies for the 2008 through 2010 tax years.

Please keep in mind that I’ve described only the highlights of the new laws enacted late in 2007. If you would like more details on any aspect of this legislation, please contact me at your earliest convenience.

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Mike Habib, EA