By KENNETH R. HARNEY, WASHINGTON
With hundreds of thousands of homeowners having negotiated loan modifications or short sales or been foreclosed upon during the past year, the Internal Revenue Service has issued fresh guidance on how to handle canceled mortgage debt in the upcoming tax season.
It's a huge issue, widely misunderstood by consumers, and involves potentially billions of dollars of tax liability. When most debts are canceled by a creditor, such as unpaid balances on student loans or credit cards, the forgiven amounts are treated as ordinary, taxable income by the Internal Revenue Code. But under a special exemption adopted by Congress covering distressed home mortgages, many owners can escape the ultimate double-whammy: Getting kicked while you're down, hit with extra taxes because your mortgage went seriously delinquent or you lost your house.
In its latest guidance, the IRS focuses on several key points that owners -- and former owners -- need to know. Tops on the list: Just because a lender wrote off a portion of your mortgage debt, this doesn't mean you automatically qualify for special tax treatment. To the contrary, there are essential tests you need to pass to qualify: The debt your lender canceled must have been used by you "to buy, build or substantially improve your principal residence." There's a lot packed into these words, so it's important to parse them carefully. Start with the house itself. It can't be your second home, an investment condo, a weekend retreat or a seasonal home you occupy for less than half the year. It can only be your main residence, and fully documentable as such.
Next, the unpaid mortgage balance your lender canceled as part of a modification, short sale or foreclosure cannot have been used for non-qualifying purposes, i.e, for something other than acquiring or constructing the house or making capital improvements to it. Refinanced mortgage debt used for kids' tuitions, vacations, buying cars or paying off credit card bills won't make the grade. The IRS offers a hypothetical example of how borrowers can mess up their chances for tax relief. A taxpayer took out a first mortgage of $800,000 when he purchased his home years ago. Thanks to strong appreciation in property values, the house was soon worth $1 million and the owner refinanced the mortgage to $850,000. The loan balance at the time of the refi was down to $740,000, and the owner used the $110,000 in cash-out proceeds to buy a new car and pay off credit card debts. Bad move. A year or two later -- presumably well into the recession and housing bust -- the home value had plunged to between $700,000 and $750,000. The owner then convinced his bank to allow a short sale for $735,000 and to cancel the remaining $115,000 of unpaid debt. Does the owner get tax relief on the full $115,000 under Congress' special exemption? No way, according to the IRS. He only escapes income taxes on just $5,000 of the $115,000 because he spent the other $110,000 on a car and credit card balances -- neither of which counts as "qualified principal residence" debt.
Greg A. Rosica, a tax partner with accounting giant Ernst & Young, says misunderstandings of the rules about mortgage debt forgiveness are "commonplace." People often don't know that "the equity line (money) you used for vacations" and other purposes "just will not qualify" under IRS rules. Taxpayers who walk away from their houses may be liable for taxes, said Rosica in an interview, if at some point the property "no longer was their primary residence" -- say they rented it out for the period between their last payment and the foreclosure -- effectively converting the house into rental property, not their principal home.
The IRS highlighted some other key points in its guidance: -- Mortgage cancellation relief is capped at $2 million for singles and married taxpayers, $1 million for married owners filing separately. -- Anyone who's had mortgage debt cancellation as part of a loan modification or foreclosure should go to IRS.gov and download Form 982 and IRS Publication 4681 for additional filing details. Alternatively they can call 800-TAX-FORM to request copies. Lenders who write off unpaid mortgage balances typically provide borrowers with a year-end IRS form 1099-C cancellation of debt statement, including the amount of the loan forgiven and the fair market value of the property. If you've had mortgage debt canceled but have never received a 1099-C from your lender, get in touch and request it if you want to avoid federal tax hassles.
Ken Harney's e-mail address is kenharney(at)earthlink.net. (c) 2011, Washington Post Writers Group
A Colonial-style mansion on Long Island Sound that some say was the inspiration for parts of F. Scott Fitzgerald's "The Great Gatsby," a novel of Jay Gatsby's boom-and-bust 1920s, is set to be torn down and the land divided into several multi-million dollar home sites, according to stories in the New York Post and Newsday. After a rich social and literary history, Lands End - a once-grand 25-room mansion - is now dilapidated and empty. The property is along a stretch of shoreline called "The Gold Coast" where many once-grand gilded-age manses have fallen victim to tough economic times and have met the same fate as Lands End.
The owner of the house bought it in 2004 for $17.5 million and disputes claims that it was the inspiration for the novel, but says that it costs upwards of $4,000 a day to maintain the property.
Fitzgerald was born in St. Paul, where he lived for several years at various times. The stage version of "Gatsby" got its world premiere in Minneapolis in 2006 to commemorate the opening of the new Guthrie Theater building along the Mississippi River.
CoreLogic said today that the number of homeowners across the country who have a mortgage that's more than the value of their house rose slightly from 22.5 percent during the 3rd quarter 2010 to 23.1 percent by the end of the year.
In the Twin Cities metro area 16.8 percent, or 80,705, residential mortgages were in a negative equity position during the fourth quarter. Another 5.3 percent were in near negative equity in the Twin Cities, meaning that they were very close to owing more than their house was worth.
These negative equity reports, which are produced by several entities, have been somewhat controversial because it's a measure that only applies to homeowners who HAVE a mortgage, and it's only important if that person is planning to sell. At any given time, only about 5 percent of all homes are on the market.
Earlier this year Zillow sent a shudder through the local housing market when it said that 42 percent of all Twin Cities homeowners were underwater on their mortgages at the end of the year, significantly more than the 27 percent figure for the nation.
Though contractors are HUNGRY for work and you'll probably save on labor costs, several reports suggest that prices on construction materials of all sorts are rising. This afternoon the Associated General Contractors of America said that during January a broad index of construction materials rose 0.9 percent on top of a 4.9 percent increase over the previous 12 months. Prices are particularly high for diesel fuel and anything made with steel. A story in the Los Angeles Times details some of the issues. Was also a recent story by my colleague, Susan Feyder, about the issue in the Star Tribune.
A new quarterly survey says that while new home construction is still struggling, the remodeling market has hit bottom and is poised to improve during the coming year. Remodeling Magazine's Residential Remodeling Index, which ranks the top 100 hottest remodeling markets nationwide, says that the Twin Cities metro area was No. 3 overall in terms of remodeling activity during the third quarter 2010. Cincinatti and Houston topped the list.
The survey, which is based on building permit data and other information, suggests that remodeling activity has picked up significantly and is expected to grow during the coming year. That's not a surprise given the stagnant housing market. With sales falling many homeowners are optiong for fix-up projects instead of selling. Here's a link to the full report, which includes details on the 2011 forecast.
While home sellers are cursing, landlords are clapping; the stagnant housing market has been a boon for landlords. Last year was a record year for rental absorption rates, which means that more apartments were rented in 2010 than ever before, according to a year-end report from GVA Marquette Advisors. The report said that during 2010 6,400 market rate units were rented; that compares with a loss of 3,450 renters in 2009.
GVA also credits improvments in the economy for boosting the number of new renters, who spent the last couple years doubling up in apartments, moving home or choosing not to move at all.
Rents have remained stable this year, but with not enough construction to equal new demand, expect rents to rise during 2011.