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Beware the Phantom Tax

Joseph A. Wolf, CPA (RE/MAX BEYOND 2000 REALTY) — Thu, 10 May 2007 22:29:35 -0500

Beware the Phantom Tax

As if things weren't bad enough for some poor folks unable to make their mortgage payment. Many distressed homeowners are just now realizing that even if they can get out from under their mortgage by "short sale" they will face an income tax liability on their debt cancellation. What? Read on.

CURRENT NEWS

A popular trend in residential real estate sales tactics is the proposed "short sale". This is a situation where the homeowner offers to sell their house, subject to "short sale" approval by their lender. A "short sale" occurs when the sale price of the home is less than the outstanding mortgage balance and the lender forgives the difference by releasing the seller from the remaining amount owed.

There are many reasons why a homeowner may owe more than their house is worth, including declining market values. And, as you can imagine, "short sale" approval from lenders is not easy to obtain. So in many cases a "short sale" tactic is a long-shot one, at best. But if a "short sale" is approved by your lender beware the phantom tax.

BAD NEWS

Under current Internal Revenue Service regulations an individual will be required to pay income tax on the difference between the "short sale" price of their home and the loan balance; i.e., the amount of cancelled debt. The effect of this rule is that "short sale" home sellers will generate an income tax on "paper profits", income that they do not actually receive.

Here's how it works. Suppose you owe $100,000 on your home mortgage and the best you can sell your house for is $90,000. If your lender will allow a "short sale", and you can find someone to buy your house, you will generate $10,000 in cancelled debt on the transaction, which will be included as ordinary income on your federal Form 1040, Line 21.

Table-1.

1) Amount of debt cancelled (loan balance)	$100,000
2) - Less: Fair market value of property (sale price)	- $90,000
3) = Equals: Income from cancellation of debt [1-2]	= $10,000
4) x Times: Effective tax rate	x 15%
5) = Equals: Income tax payable [3x4]	= $1,500

This calculation applies to simple "short sale" transactions. The tax also applies to foreclosures and repossessions, although there is an additional calculation to determine gain or loss.

There are only a few exceptions to this tax, the most common being bankruptcy. If your property is foreclosed in bankruptcy the foregoing does not apply.

WORSE NEWS

Your lender is REQUIRED to issue you Form 1099-C for the amount of debt cancelled and must also report this amount directly to the IRS. Be aware that if you sell your house in "short sale" during 2007 you WILL receive a 1099-C in January, 2008 for the cancelled debt amount.

GOOD NEWS (MAYBE)

Help may be on the way. On April 17, 2007 H.R. 1876, the "Mortgage Cancellation Relief Act of 2007", was introduced by Rep. Robert Andrews [D-NJ] in the House of Representatives. If passed by Congress and signed by the President this law will create a new exemption for "qualified residential indebtedness". This would relieve taxpayers of the phantom tax on "short sales", foreclosures and repossessions. The bill has been referred to the House Ways and Means Committee. It has strong support from the National Association of Realtors.

If passed, the amendments made by this legislation will apply to discharges of debt AFTER the date of enactment of the Act. Therefore, taxpayers will not be relieved of the phantom tax unless and until the new law is passed. There are no retroactive provisions in the Act.

CONCLUSION

Homeowners contemplating a "short sale" should take into account the tax implications, and also the timing of the transaction relative to pending legislation. See your tax preparer or CPA for specific advice.

Joseph A. Wolf, CPA

Licensed Real Estate Broker

RE/MAX BEYOND 2000 REALTY

6370 York Road

Parma Heights OH 44130

(800) 219-9471

joseph.wolf@remax.net

www.BuyersAgentSaves.com

Title Closing Protection Coverage

Joseph A. Wolf, CPA (RE/MAX BEYOND 2000 REALTY) — Tue, 30 Jan 2007 22:31:22 -0600

Title Closing Protection Coverage (Predatory Lending Law) January, 2007

A new Ohio law became effective January 1, 2007 which affects buyers and sellers of residential real estate. The new "Predatory Lending Law" (ORC 3953.32) requires title/escrow companies to provide a "Notice and Offer of Availability of Closing Protection Coverage" statement and a "Closing Protection Coverage" form to all parties of a real estate transaction, including lenders. Each party must sign a form accepting or declining this new protection coverage.

The new coverage protects the electing parties from specific acts of the title/escrow company, including:

Item-1) Theft, misappropriation, fraud, or any other failure to properly disburse settlement, closing or escrow funds; and

Item-2) Failure to comply with any applicable written closing instructions, when agreed to by the title/escrow company.

The title/escrow company is required to offer the Closing Protection Coverage, document its acceptance or not, and collect the state-mandated fees, if accepted; remitting such fees to the title insurance underwriter. The coverage itself is not required by law, although some lenders may require their borrowers to obtain this protection at the borrower's expense.

Good news or bad for consumers? It depends. Notice that none of the above provisions bear any relationship to the predatory lending abuses that are currently being prosecuted in Cuyahoga County, Ohio. On the contrary, those cases typically target alleged abuses by predatory LENDERS (typically mortgage brokers), sometimes in collusion with appraisers, buyers, sellers and real estate agents. Predatory lending practices, by definition, are perpetrated by unscrupulous lenders and their co-conspirators, not title/escrow companies. None of the recent wave of alleged predatory lending abuses involves the type of conduct stated in Item-1 and Item-2 above by a title/escrow company. Yet this new law provides insurance coverage for just such an occurrence, for a user-paid fee of course.

This leaves the consumer with the following questions:

1) Should I accept or decline the Closing Protection Coverage?	9) If I accept the Coverage do I waive any other legal remedies?
2) How much does it cost?	10) If there is a violation as stated in Item-1 and Item-2 above how do I make a claim? To whom?
3) Do I need such coverage at all?	11) Are there deductibles? Are there limits of liability?
4) When do I make this decision?	12) If I receive a reimbursement under this Coverage are my rights subrogated to the insurer?
5) Can my lender force me to accept Coverage?	13) Do I retain my HUD RESPA Sec. 8 and Sec. 9 rights and remedies?
6) Is this required for a cash purchase?	14) Is the title/escrow company licensed, bonded and insured?
7) Aren't the actions stated in Item-1 and Item-2 above illegal under current law already?	15) Does the title/escrow company maintain a state-regulated trust account?
8) If so, are there present legal remedies for the actions stated in Item-1 and Item-2 above?	16) Does the title/escrow company's Letter of Acceptance negate any of the Coverage provisions (see Item-2 above)?

BOTTOM LINE
Question-1: Is this really an important issue? Answer-1: It depends.

Question-2: Is this just another regulatory compliance issue? Answer-2: It depends.

Question-3: Who really benefits from all of this? Answer: it depends.

SOLUTION
I provide each of my clients the answers to ALL of the above questions, based upon their specific circumstances. To understand your options with regard to this new Ohio law consult your qualified, licensed real estate broker.

Tax Deductible PMI?

Joseph A. Wolf, CPA (RE/MAX BEYOND 2000 REALTY) — Tue, 30 Jan 2007 22:28:13 -0600

Tax Deductible PMI? January, 2007

The federal tax law was recently modified to create a new deduction for mortgage insurance premiums. Homebuyers in 2007 should be aware of the new tax benefits now available to them.

OLD NEWS
Historically private mortgage insurance (PMI) has not been deductible for federal income tax purposes, unlike the mortgage interest deduction. This has caused great consternation to consumers because they were forced to pay the PMI "penalty" for making a low down payment, yet realized no tax benefit for this amount.

IMPLICATIONS
Accordingly consumers have often opted for "no PMI" loan programs (split-second, 80/20, 90/10, etc.). Although many of these programs appear to remove the mortgage insurance (MI) cost, they actually shift the cost from a non-deductible component (MI) to a deductible component (interest). In other words, the cost is not eliminated, it is reconfigured. Strictly speaking, there is no such thing as a "no PMI" loan. The MI cost remains; it is simply shifted and re-characterized.

TROUBLE
The problem is that many of these "no PMI" loan programs are actually more costly than a simple loan with PMI, even considering the tax deductibility of the mortgage interest component. Each loan program must be analyzed and the net-after-tax cost should be computed in order to determine the most favorable mortgage loan program.

GOOD NEWS
Late in December, 2006 congress passed H.R. 6111 and the president subsequently signed into law the "Tax Relief and Health Care Act of 2006", also known as Extender Legislation. Buried in a myriad of multi-faceted tax issues is a new provision which provides for a tax deduction of mortgage insurance (MI), subject to certain restrictions. This new deduction applies to private MI, as well as FHA and VA MI costs. The MI premium amount will be treated as mortgage interest in calculating the deduction.

FINE PRINT
Of course, restrictions do apply. The deduction applies only to MI policies issued in 2007 for homes purchased in 2007. A deduction may also be available for certain refinances in 2007 as well. There are also adjusted gross income (AGI) limitations and phase-out provisions. Under current tax law this provision will expire for any MI premium payment paid after December 31, 2007. Also, prepaid MI and unamortized MI premiums are not allowed. For details see your tax advisor.

BOTTOM LINE
Consult your qualified, licensed real estate broker to understand your options with regard to this new MI provision.