FORECLOSURE & MORTGAGE DEBT FORGIVENES

1. FORECLOSURE & MORTGAGE DEBT FORGIVENES WHAT ARE THEY? WHY ARE WE CONCERNED? IRS Pub 4702 IRS Pub 970

2. DEFINITIONS • Foreclosure: Takeover of property by lender • Reportable ON Sched D; Possible Capital Gain may be Reduced by Exclusion • Cancellation of Debt; Reduction in Liability of Debtor due to Foreclosure, Repossession, or Negotiation. • Debt Forgiveness: Cancelled Debt which the taxpayer may exclude from income.

3. DEBT CANCELLATION • What is it? • Reduction or Cancellation of Debt by Lender • IRS Considers this to be Income • Lender Issues Form 1099-C • Normally must be Included on Tax Return, Line 21 as Other Income • Can result in Debt Forgiveness

4. DEBT CANCELLATION • Example: Credit Card Debt of $15,000; Borrower 6 months in arrears: Lender accepts $10,000 and closes out account. • Borrower has $5,000 of Income

5. FORM 1099-C OUT-OF SCOPE

6. Foreclosure –Real Property • Foreclosure –Results in a Sale of Property from debtor to creditor (Form 1099-A) • May have Capital Gain or Loss • If Personal Residence, No Loss Allowed • Taxpayer will Receive Form 1099-A from creditor • May also have Income from Cancelled Debt • Will Receive Form 1099-C

7. FORM 1099-A

8. Foreclosure –Real Property • Recourse Debt – Debtor Responsible for Amount not Satisfied by Property • Possible Income from Cancelled Debt (1099-C) • Capital Gain Income Possible • Nonrecourse Debt – Debt Satisfied by Surrender of Property • No Income Due to Cancelled Debt • No 1099-C will be issued • Possible Gain Due to “Sale” of Property (1099-A)

9. EXCLUSION: CANCELLED DEBT • Can be Excluded under Special Conditions which are “OUT-OF-SCOPE” • Bankruptcy • Insolvency • Farm or Business Use of Property • If Excluded, Not Reported on Tax Return

10. EXCLUSION • Mortgage Forgiveness Debt Relief Act of 2007; Applies to years 2007 – 2012 • Defines Additional Exclusion which can be “IN-SCOPE”

11. IN-SCOPE EXCLUSION DEBT RELIEF ACT - 2007 • Cancelled Debt on Principal Residence May be Excluded (Forgiven) if: • Debt used to Buy, Build, or Substantially Improve Principal Residence • Debt Incurred to Refinance Debt for above purposes • Debt to Refinance Home can be Excluded Only up to Balance of old Mortgage Immediately before Refinancing

12. SCREENING • Use IRS Screening Form to Determine Eligibility: Screening Sheet For Volunteers Assisting Taxpayers with Form 1099-C, Cancellation of Debt – Personal Residence

13. IRS SCREENING SHEET • STEP 1: • Did the Taxpayer receive a Form 1099-C, Cancellation of Debt, from their lender only in relation to a home mortgage loan and is the information shown on the form correct? • YES – Go to Step 2 NO – Go to Step 6 • STEP 2: • Did the taxpayer ever use the home in a trade or business or as rental property? • YES – Go to Step 6 NO – Go to Step 3 • STEP 3: • Was the debt canceled as a result of a bankruptcy case? • YES – Go to Step 6 NO – Go to Step 4

14. IRS SCREENING SHEET • STEP 4: • Ask the following questions to determine ifthe discharged debt is “qualified principal residence indebtedness”: • a. Was the mortgage taken out to buy, build, or substantially improve the taxpayer’s principal residence? (NOTE: A principal residence is generally the home where the taxpayer lives most of the time. A taxpayer can have only one principal residence at any one time.) • YES – Go to Step 4b NO – Go to Step 6 • b. Was the mortgage secured by the taxpayer’s principal residence? • YES – Go to Step 4c NO – Go to Step 6

15. IRS SCREENING SHEET • STEP 4 (cont) • c. Was any part of the mortgage used to pay off credit cards, purchase a car, pay for tuition, pay for a vacation, pay medical/dental expenses, or used for any other purpose other than to buy, build, or substantially improve the principal residence? • YES – Go to Step 6 NO – Go to Step 4d • d. Was the mortgage amount more than $2 Million ($1 Million if married filing separately)? • YES – Go to Step 6 NO – Go to Step 5

16. IRS SCREENING SHEET • STEP 5: • A trained volunteer with an Advanced Certification may assist the taxpayer with the Form 1099-C at a VITA/TCE Site. • STEP 6: • These tax issues are outside the scope of the volunteer program.

17. CANCELLATION OF DEBT REPORTING • Taxpayer will Receive Form 1099-C • Box 2 Shows Amount of Debt Forgiven. • Must complete Form 982 and attach to Return • If Foreclosure, Complete only Boxes 1E and 2. • If Ownership retained, also complete Box 10b • No Income Reported on Line 21, Form 1040

18. IN-SCOPE • Foreclosure Reported as a sale of home from 1099-A –Must be reported on Schedule D • (May be only 1099-C if foreclosure and debt forgiveness in same year) • Cancellation of Debt Reported on Form 982 (if Recourse Debt) • 1099-A, Box 5 is YES • No Cancellation of Debt if Non-Recourse Debt • 1099-A Box 5 is NO • Selling Price is Full Amount of Debt

19. TAXWISE REPORTING • If 1099-C for a “qualified principal residence indebtedness”: • Open Form 982 from Forms List • Check Box 1e; Enter Value from 1099-C, Box 2 on Line 2. • If Property NOT Foreclosed, • Enter 1099-C Box 2 Amount on Line 10 of Form 982

20. FORM 1099-C 07/15/2008 50,000.00 HOME MORTGAGE LOAN

21. FORM 982

22. FORM 982 • If Debt Forgiven and Ownership Retained: • Reduce Basis by Amount of Forgiven Debt FORM 982, LINE 10B

23. Foreclosure –Real Property • RECOURSE (Borrower Personally Responsible) - Taxpayer should have Form 1099-A • Box 2 Shows Balance of Debt Outstanding • Box 4 Shows FMV of Property • Lesser Value is Sales Price • NON-RECOURSE • Box 2 is Sales Price

24. FORM 1099-A

25. Foreclosure –Real Property • In Taxwise, • Select Sched D Wksht 2 from Forms List • 1099-A, Box 1 is Date of Sale • 1099-A, Box 2 or Box 4 is Sale Price • Complete Wksht 2, “Sale of Your Home” through Ln 14 • Ln 14 value must be entered Manually on Sched D. Does NOT Carry over from Worksheet

26. EXAMPLE Mary Smith purchased her main home in June 2003 for $175,000. In 2008 she lost her job and was no longer able to make her payments on this recourse mortgage. In July, Mary moved out of the home to live with relatives. On July 15, 2008 the bank foreclosed on the home and canceled the remaining amount owed on the home. The fair market value at the time was $100,000 because of the poor housing market, but Mary still owed $150,000 on the mortgage. None of the loan proceeds were used for any purpose other than to buy, build, or substantially improve the principal residence.

27. FORM 1099-A 150,000.00 MARY SMITH 100,000.00 X 1111 LOST DRIVE Your City, YS, ZIP

28. MARY SMITH FORECLOSURE SCHED D, WORKSHEET 2

29. MARY SMITH FORECLOSURECAP GAIN WORKSHEET - LOSS MUST OVERRIDE to 0

30. MARY SMITH FORECLOSURESCHED D ENTRY – LOSS

31. EXAMPLE 2: FORECLOSUREGAIN WITHIN EXCLUSION • Mary Smith purchased her main home in June 2003 for $175,000. (From 1st Example) • Change purchase price to $80,000

32. MARY SMITH FORECLOSURESCHED D, WORKSHEET 2 - GAIN

33. MARY SMITH FORECLOSURENON-TAXABLE GAIN 2ND Entry Required to Record Exclusion -= Zero out Gain

34. MARY SMITH FORECLOSURENON-TAXABLE GAIN F3 TO “GET RED OUT

35. DEBT FORGIVENESS QUESTIONS? COMMENTS?