Mortgage Relief Act and definition of 'Principle' Residence

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Latest post Sun, May 13 2012 9:36 PM by MichiganCondo. 38 replies.
  • Sat, Mar 19 2011 9:37 PM In reply to

    • Webhead
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    I hope you can shed some light to our specifc situation.  We purchased a home in 2003 - refinanced in 2005 then took a 2nd out on it also in 2005.  We lived there until September 2010.  At that time we purchased another home and moved into it.  We rented out our old home thinking this was going to be a good tax deduction - wrong.  We pay an extra 1000.00 on top of what the renters pay for the old house.  The most that we can right off is 5000.00 according to our accountant.  We owe 300K and it is estimates to be 135K.  We are looking at a short sale.  With all the discussions I am not sure if we still qualify for the mortgage relief act and how the section 121 will affect us.  Our accountant says we are close to the insolvency rule but not for sure until all is completed.  Appreciate your help.

     

  • Wed, May 11 2011 6:42 PM In reply to

    • TaxMatt
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    Under your facts, the condo was not your principal residence when it was foreclosed upon and hadn't been for nearly 3 years. As a result, it would not qualify for the relief of § 108(a)(1)(E). The bill was meant to help homeowners when restructuring debt on their current home or when they lose that home home to foreclosure.

     While I do not specialize in §108 of the code and have not read much case law on this topic, a friend asked me to look at a matter similar to the one submitted above.  In reading the above emails, especially when considering the timing issues pertinent to another §108 exclusion, qualified real property business indebtedness under §108(a)(1)(D), there appears to be a strong argument that the qualified principal residence indebtedness exclusion may be available to a taxpayer even years after having moved out of their home, provided that the real property was in fact their home on the day the debt was issued.  I agree and support many of Taxagent’s comments above, but I do not necessarily agree with Taxagent’s assumption that qualified principal residence indebtedness is defined by the date the debt is forgiven, rather than the date of debt issuance.  By the qualified real property business indebtedness exclusion under §108(a)(1)(D), the excludable debt is specifically characterized at the time the debt is issued and clearly not characterized or defined by the date it is forgiven.  The same argument, I believe, holds true for the §108(a)(1)(E) exclusion.  See as follows…       

    The fundamental provision under §108(a)(1)(E) allows the exclusion provided that the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2013.  Under §108(h)(2) “qualified principal residence indebtedness” means acquisition indebtedness [within the meaning of section 163(h)(3)(B)].  Seeing this reference to §163, I was somewhat discouraged as I know this section refers to Qualified Residence Interest for taxpayers to deduct interest payments on their house, and if you move out of your house and collect rent, you cannot deduct mortgage interest payments under §163.  However, looking closer at the definition of Qualified Residence Interest, it is defined “as acquisition indebtedness with respect to any qualified residence of the taxpayer.”  For now, look past the definition of the acquisition indebtedness to the qualified residence, which is defined as the §121 principal residence, plus one more residence.  Therefore, it is possible to have acquisition indebtedness and no home mortgage interest deductions because the taxpayer no longer lives in a qualified residence, such as if the taxpayer moves out of the home and rents the property.  Using this same analogy, it would be possible to satisfy §108(a)(1)(E) because acquisition indebtedness exists, even though the house is not a qualified residence.  Acquisition Indebtedness is actually defined under §163(h)(3)(A) as “any indebtedness which (I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and (II) is secured by such residence.”  If you combine the code language with the following IRS language, it appears that qualified principal residence indebtedness is defined on the day it was created, not determined on the day the debt is forgiven.    

     “The debt must have been used to buy, build or substantially improve the taxpayer's principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.” 

    -IR News Release 2008-17 02/12/2008

    "Qualified principal residence is any mortgage you took out to buy, build, or substantially improve your main home. It also must be secured by your main home. Qualified principal residence indebtedness also includes any debt secured by your main home that you used to refinance a mortgage you took out to build or substantially improve your main home...."

    -IRS Publication 4681

  • Thu, Jun 16 2011 6:05 PM In reply to

    • OregonTexan
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    We are trying to discern the best route for our situation.

    We bought a house in Oregon in Aug. 2007. Lived there until we lost our jobs which caused us to find new employment in Texas. Moved to TX in July 2009, began renting Oregon house in Aug. 2008. Now renters are moving out effective July 31, 2011. We had jobs in Texas but lost those recently and are trying to find employment. The questions are:

    1. Having lived in the Oregon house for approx. 2 years, would it behoove us to move back into it as we prepare to do a short sell? If we did this, only one of the spouses would move back since 2 of our kids are about to graduate HS and we are trying to give them a little stability for the next year. We are willing to get voter registration, bills, etc in Oregon till we can sell the house.

    2. How long does "principal residency" need to be established to qualify us for the Mort. Forgiveness/Relief Act to be an option for us?

    2.5 Does relocation for jobs qualify as a special event regarding residency and Mort. Forgiveness act?

     3. A house down the street in Oregon short sold for approximately $85000. less than our current note we owe on the Oregon house, should we short sell or is there another better option?

    We bought a house in Texas thru seller financing but we have it listed to sell. we have only lived here in the Texas house 11/2 years (rented for a few months in Texas), lived in Oregon house for 2 years. have not quite met the 5 year issue..if it is one. we are current on both the house notes, but have lost approx. $500/month for Oregon house since rent payment does not cover mortage.

    There is no way we will be able to carry both mortgages come Sept. 2011. What will happen to the possibilities of qualifying for Mort. Forgiveness act if we cannot make the payments..thus expediting the short sale possibility?

    Thanks for your help!

  • Thu, Jun 16 2011 6:36 PM In reply to

    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    Please understand that your questions involve issues of personal choice so all I can give you are personal obversations with some resources thrown in.

    OregonTexan:
    . Having lived in the Oregon house for approx. 2 years, would it behoove us to move back into it as we prepare to do a short sell? If we did this, only one of the spouses would move back since 2 of our kids are about to graduate HS and we are trying to give them a little stability for the next year. We are willing to get voter registration, bills, etc in Oregon till we can sell the house.

    My personal opinion is to stop making payments on the OR house and let it go to foreclosure. Just abandon it to the lender and never look back. Here's why. First, and most important, a short sale trashes your credit. Maybe not as bad as a foreclosure but close enough not to make much difference. You gain nothing from a short sale.   But what you do get is to live apart from your family and hassle with the bank and buyers for 6 months or more with no guarantee that a short sale will ever be approved.

    OregonTexan:
    How long does "principal residency" need to be established to qualify us for the Mort. Forgiveness/Relief Act to be an option for us?
     

    I doubt if you would qualify if part of your family lives in one home and you live in the other. IRS Publication 4681, Page 8 says:

    "Your main home is the home where you ordinarily live most of the time. You can have only one main home at any one time."

    http://www.irs.gov/pub/irs-pdf/p4681.pdf

    OregonTexan:
    Does relocation for jobs qualify as a special event regarding residency and Mort. Forgiveness act?

    I don't know. You'll have to read Publication 4681.

    And here's some additional information from the IRS:

    http://www.irs.gov/individuals/article/0,,id=179414,00.html

    OregonTexan:

    There is no way we will be able to carry both mortgages come Sept. 2011. What will happen to the possibilities of qualifying for Mort. Forgiveness act if we cannot make the payments..thus expediting the short sale possibility?

    Realistically, you are probably heading for bankruptcy, even if you might not like to admit it. I doubt that you will get either house sold by Sept in the current market. If you can't, you'd be better off pulling the plug on the OR house and staying with your family in TX and keeping the TX house where you are currently established and have the kids in school. After all, you have to live somewhere and if you are not underwater on the TX house, then that's the one to salvage.

    Oregon is apparently a non-recourse state and there is always the possibility that you can exclude the tax on the deficiency under the insolvency laws if you can't do it under the Mortgage Forgiveness Act.

    Again, just my personal opinion.

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  • Tue, Aug 23 2011 8:54 PM In reply to

    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    I'm a little unclear and need to understand if I qualify under the Mortgage relief act. Below are the facts:

    I purchased a 2 family residence 4 years ago. Since its a 2 family i lived in one of the units since i purchased it and rented out the other unit. A few days ago was notified by the bank that they would discharge my home equity loan which was used to purchase the house. I wanted to know if the discharge of the home equity loan should be excluded from income based on the Mortgage relief act or if i would need to include it in income since the house which is a principal residence was partially rented. Please advise.

  • Tue, Jan 10 2012 12:51 AM In reply to

    • buddy1234
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    Looking at all of the data points, it appears that the only logical conclusion is to follow the 2 of 5 year rule as it is referenced in both the relief act itself (although we can get cought up in semantics) as well as the gains portion in the link below. Non-recourse borrowers are definately safe with this interpretation and it appears that congress intended for this interpretation in referencing section 121.

    http://www.irs.gov/newsroom/article/0,,id=174034,00.html

    Use the following steps to compute the income to be reported from a foreclosure:

    Step 1 - Figuring Cancellation of Debt Income (Note: For non-recourse loans, skip this section.  You have no income from cancellation of debt.)

    1. Enter the total amount of the debt immediately prior to the foreclosure.___________
    2. Enter the fair market value of the property from Form 1099-C, box 7. ___________
    3. Subtract line 2 from line 1.If less than zero, enter zero.___________

     

    The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C.  This amount is taxable unless you meet one of the exceptions in question 2.  Enter it on line 21, Other Income, of your Form 1040.

    Step 2 - Figuring Gain from Foreclosure

    4. Enter the fair market value of the property foreclosed.For non-recourse loans, enter the amount of the debt immediately prior to the foreclosure ________
    5.    Enter your adjusted basis in the property.(Usually your purchase price plus the cost of any major improvements.)                                    ____________
    6. Subtract line 5 from line 4.  If less than zero, enter zero.   

    The amount on line 6 is your gain from the foreclosure of your home.  If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income.  If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.

    Another opinion here: http://stevebeede.com/2010/06/debt-forgiveness-relief-another-look-at-the-personal-residence-exclusion/

     


  • Tue, Jan 10 2012 2:50 PM In reply to

    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    I have a similar situation and would like an experts opinion. In May 2006 I purchased a property for $190K. I put the house on the market in March 2010 and moved in with my fiancé (now wife) in April 2010. I moved out it hopes it would help sell the house faster. I had an agreement of sale that fell through in July 2010 when a home inspection identified major issues with the homes foundation (I was not aware of these issues). As a result of the foundation issues I was forced to do a short sale. The house sold for $106K on March 15, 2011. The deal would have gotten done in Oct/Nov 2010, but the bank took awhile to approve the sale. My total debt forgiven was $70K. Under this fact pattern, would I qualify to exclude the debt forgiveness from income by virtue of the Mortgage relief act?

  • Tue, Jan 10 2012 5:14 PM In reply to

    • buddy1234
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    Let me clarify my explanation (note: I am not a lawyer. Do not consider this legal advice. Every situation is different):

    There are two main types of taxable events that can occur when debt is forgiven:

    1. Cancelation of Debt Income (CODI)

    2. Capital Gains (CG)

    WRT Foreclosure:

    CASE 1: In the case of a non-recourse loan (CA, AZ, etc.) no CODI is realized by the debt holder as the only recourse for the bank is to go after the property. CG may be realized and is calculated by subtracting the borrower’s adjusted basis in the home from the amount owed on the note at time of foreclosure. This tax may be avoided (gains up to 250k single, 500k married filing jointly) if the house was lived in as your primary residence for at least two of the last five years leading up the day of foreclosure. This protection is based on section 121: Exclusion of Gain from Sale of Principal Residence.

    CASE 2: In the case of a recourse loan, CODI as well is CG may be realized by the borrower. CODI = outstanding loan balance minus fair market value. The bank will specify the value in a 1099-c. CG is calculated differently compared to non recourse loans. CG = fair market value - adjusted basis. Until recently, the CODI tax could not be avoided.

    MDRA: The Mortgage Debt Relief Act of 2007 (extended through 2012) is intended to protect borrowers with recourse loans from CODI taxation WRT forgiven debt for a principal residence. This act specifically calls out section 121 stating in Section 2, part 5: (5) PRINCIPAL RESIDENCE- For purposes of this subsection, the term 'principal residence' has the same meaning as when used in section 121. This is where there is room for interpretation based on semantics. Does this language indicate that the single term "principal residence" is to be interpreted as in section 121 OR does this language indicate that the "smell test" outlined in section 121 for the exemption should be followed for MDRA tax protection.

    IMO, one can strongly argue that the IRS has set a precedent for forgiving taxes WRT principal residence based on the protection for CG in section 121. One can also strongly argue that the spirit of the reference to section 121 is to in fact provide a rule of thumb for what qualifies for protection. Otherwise why reference section 121 that explicitly calls out this 5 year rule? Why not simply reference the IRS definition of the singular term "principal residence"? After all, why would the IRS be willing to forgive CG tax based on this rule but not forgive CODI tax? If the spirit of the reference was not intended to call out the 5 year rule, then congress has once again created a very ambiguous situation.

  • Tue, Jan 10 2012 5:48 PM In reply to

    • buddy1234
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    Additionaly, congress passed the Emergency Economic Stabalization Act of 2008 which provided the TARP bailout and extended the Mortgage Debt Relief Act of 2007 through 2012. The joint committee report resulting from the EESA of 2008 (intended to clarify the application of law) states that the meaning of principal residence for the purposes of the Qualified Principal Residence Income exclusion is the same as in section 121 (i.e. the 2 of 5 year rule).

    Reference: http://stevebeede.com/2010/06/debt-forgiveness-relief-another-look-at-the-personal-residence-exclusion/

     

  • Tue, Jan 10 2012 6:14 PM In reply to

    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    buddy1234:
    IMO, one can strongly argue that the IRS has set a precedent for forgiving taxes WRT principal residence based on the protection for CG in section 121.

    I'm a tax lawyer, and I disagree with that premise. IRC § 108(h) has the home mortgage debt discharge rule:

    _______________________

    (h) Special rules relating to qualified principal residence indebtedness (1) Basis reduction

    The amount excluded from gross income by reason of subsection (a)(1)(E) shall be applied to reduce (but not below zero) the basis of the principal residence of the taxpayer.

    (2) Qualified principal residence indebtedness

    For purposes of this section, the term “qualified principal residence indebtedness” means acquisition indebtedness (within the meaning of section 163(h)(3)(B), applied by substituting “$2,000,000 ($1,000,000” for “$1,000,000 ($500,000” in clause (ii) thereof) with respect to the principal residence of the taxpayer.

    (3) Exception for certain discharges not related to taxpayer's financial condition

    Subsection (a)(1)(E) shall not apply to the discharge of a loan if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the financial condition of the taxpayer.

    (4) Ordering rule

    If any loan is discharged, in whole or in part, and only a portion of such loan is qualified principal residence indebtedness, subsection (a)(1)(E) shall apply only to so much of the amount discharged as exceeds the amount of the loan (as determined immediately before such discharge) which is not qualified principal residence indebtedness.

    (5) Principal residence

    For purposes of this subsection, the term “principal residence” has the same meaning as when used in section 121.

    _______________________

    Thus, § 108(h)(5), which defines principal residence, is quite clear— it means principal residence as used for §121. IRC § 121 is a section that provides exclusion of gain realized on certain principal residences. Not all sales of a principal residence qualify for exclusion under § 121. That tells you that the term "principal residence" is NOT synonymous with qualifying for the exclusion under § 121. Had Congress meant for the home mortgage debt exclusion to be restricted to homes that qualify for the gain exclusion, it would have said so, e.g. "principal residence means a residence that qualifies for the exclusion of gain under § 121." This is important because IRC § 108(h)(5) allows for relief for home mortgage discharges even if the requirements for gain exclusion of § 121 were not met. In that regard, § 108(h) is broader than IRC § 121. Your interpretation would make it the statute even more restrictive, not less. Paragraph (h)(5) is not where I see any uncertainty in the statute.

  • Tue, Jan 10 2012 9:32 PM In reply to

    • buddy1234
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

     

    I can certainly follow your interpretation of the language and it *may* very well be correct. I feel the argument for the restrictiveness of 121 and its transference to 108 is flimsy. Attorney TaxMatt also makes some very plausible arguments for interpretation of principal residence in the context of when the debt was issued vs. the date the debt was forgiven. He *may* also be correct. A single interpretation after all is just that: an interpretation.

    It is virtually impossible to stay in your primary residence up until the day of foreclosure and I suspect that the majority of homeowners do not. I doubt the intent of congress was to strip these people of their tax shelter when writing the law. I still contend that the reference to 121 is obscure if it was simply to transfer the meaning of "principle residence" with no other context. This could have been done in a much more direct way if that was the sole intent of the reference. I feel the intent of the reference may not be in line with the technical semantic interpretation.

    As I read dozens of attorney's interpretations of this law language it is clear that there is no consensus among the law community therefore, by definition, we have ambiguity. Thousands of tax payers with foreclosures will be claiming protection under the forgiveness act and a large portion of them will be following the 2 of 5 year rule due to the lack of clarity in the law and advice from their accountants and attorneys. The IRS will have a very large mess to clean up if they choose to pursue the various interpretations of this act. All we tax payers can do is hear as many professional opinions as possible and take a reasonable path forward with regard to out particular situation.

    I am fortunate enough to not have to worry about this specific protection as I had a non-recourse loan when my house went into foreclosure and I am protected from capital gains using the 2 of 5 year rule. If I had a recourse loan, given the specific circumstances of my case, I would take protection having lived in my house for 3 of 4 years as a principal residence and never having rented it for income.

  • Tue, Jan 10 2012 11:11 PM In reply to

    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    buddy1234:
    I still contend that the reference to 121 is obscure if it was simply to transfer the meaning of "principle residence" with no other context. This could have been done in a much more direct way if that was the sole intent of the reference.

    The reason Congress did it that was was that it wanted a uniform definition of personal residence. By referencing the definition in §121, it assured that should the IRS change or refine it's definition of personal residence for §121 (or the courts do so) those changes would apply then to § 108(h). This is common when drafting tax provisions when uniformity is sought; the cross-references make it aggravating to read at first, but it serves the purpose of ensuring that if one provision is changed later, the related provisions will get the same treatment automatically.

    buddy1234:
    Attorney TaxMatt also makes some very plausible arguments for interpretation of principal residence in the context of when the debt was issued vs. the date the debt was forgiven. He *may* also be correct. A single interpretation after all is just that: an interpretation.

    That is where I think the ambiguity lies, and where tax lawyers like myself and others have difficulty: the concept of testing WHEN the requirements must be met for being a prinicipal residence, not whether it met the definition of a principal residence.

    buddy1234:
    It is virtually impossible to stay in your primary residence up until the day of foreclosure and I suspect that the majority of homeowners do not. I doubt the intent of congress was to strip these people of their tax shelter when writing the law.

    I agree; I don't think that the homeowner has to live in the home up to the very day of foreclosure or debt forgiveness to get the benefit of § 108(h). Thus, the usual circumstance in which the house remains vacant for a few months before the foreclosure I don't see as posing a problem in claiming the relief under § 108(h). On the other hand, if the property was converted to a rental before the foreclosure, that raises some difficulties that I think the drafters of the statute didn't really contemplate. And there, the specific facts may make a difference in the outcome.

  • Tue, Jan 10 2012 11:56 PM In reply to

    • buddy1234
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

     

    These are excellent responses Taxagent. Is there any case law available to clear up ambiguities regarding WHEN the requirements must be met for principal residence? I assume the IRS has performed audits in relation to this debt forgiveness act since it has been around since 2007. Are the IRS's interpretation and application of law made public regarding audits or does a case have to end up in court before it is public record?

    Granted that there is ambiguity regarding WHEN to apply the principle residence rule, I doubt an individual filing for protection under the debt forgiveness act using the 2 of 5 year rule could be singled out for any sort of tax fraud (as there must be clear intent to defraud) but they obviously might owe back taxes and fees. Would you agree? What other liabilities might the tax payer be open to if deciding to liberally interpret the law and claim protection?

  • Wed, Jan 11 2012 1:07 PM In reply to

    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    Taxagent, I find your answers very informative but I'm still a little unclear if I qualify under the Mortgage relief act. Below are the facts:

    I purchased a 2 family residence 4 years ago. since I only put 10% down i needed two loans, a primary mortgage and a home equity loan. I live in one of the units and rent out the other unit. A few days ago I was notified by the bank that they would discharge my home equity loan (the primary mortgage still exists). I still live in my house and don't intend on selling it in the near future. I wanted to know if the discharge of the home equity loan should be excluded from income based on the Mortgage relief act or if it would need to be included in income since the house which is a principal residence was partially rented. Please advise.

  • Mon, Jan 23 2012 3:31 PM In reply to

    • Tylo
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    Re: Mortgage Relief Act and definition of 'Principle' Reside...

    buddy1234:

     

    These are excellent responses Taxagent. Is there any case law available to clear up ambiguities regarding WHEN the requirements must be met for principal residence? I assume the IRS has performed audits in relation to this debt forgiveness act since it has been around since 2007. Are the IRS's interpretation and application of law made public regarding audits or does a case have to end up in court before it is public record?

    Granted that there is ambiguity regarding WHEN to apply the principle residence rule, I doubt an individual filing for protection under the debt forgiveness act using the 2 of 5 year rule could be singled out for any sort of tax fraud (as there must be clear intent to defraud) but they obviously might owe back taxes and fees. Would you agree? What other liabilities might the tax payer be open to if deciding to liberally interpret the law and claim protection?

    bumping the last set of questions from buddy1234.

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