Posts Tagged ‘mortgage’

Unless you’re truly a connoisseur of the Code, it might surprise you to learn that as of December 31, 2014, 56 provisions of that infernal book were written with a finite lifespan. These 56 sections — collectively referred to as the “extenders” would routinely expire, only to be — you guessed it — “extended” by Congress.

When Congress was at least pretending to do its job effectively, these provisions would be extended on a proactive basis, meaning that if they were set to expire on, say, December 31, 2011, Congress would extend them for 2012 prior to their expiration date. In recent years, however, it has become the norm for Congress to allow the provisions to expire, only to later retroactively breathe life back into them. For example, if the sections expired on December 31, 2013, Congress would allow them to expire and remain expired for the bulk of the year, only to extend the provisions in the waning days of 2014, retroactively effective back to January 1, 2014.

Continue reading on Forbes.com.


Authored by Tony Nitti, Withum Partner and writer for Forbes.com.

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The following question came into Double Taxation HQ last night:

If I have a client with a 1,200,000 mortgage that was taken out to acquire a home and no home equity loan, am I limited to deducting interest on only $1,000,000 of mortgage, since it is all acquisition debt, or can I treat an additional $100,000 of the mortgage as home equity debt even though it’s “really” acquisition debt?

It’s an interesting question, because Section 163 provides a deduction for interest on $1,100,000 of mortgage interestfor “qualified residence interest,” which is further defined as “interest paid on acquisition indebtedness or home equity indebtedness…”

Section 163(h)(3)(B)(i) further provides that acquisition indebtedness is any indebtedness that is incurred in acquiring, constructing, or substantially improving a qualified residence and is secured by the residence. However, Section163(h)(3)(B)(ii) limits the amount of indebtedness treated as acquisition indebtedness to $1,000,000 ($500,000 for a married individual filing separately). Accordingly, any indebtedness described in Section 163(h)(3)(B)(i) in excess of $1,000,000 is, by definition, not acquisition indebtedness.

Under Section 163(h)(3)(C)(i) home equity indebtedness is any indebtedness secured by a qualified residence other than acquisition indebtedness, to the extent the fair market value of the qualified residence exceeds the amount of acquisition indebtedness on the residence. However, § 163(h)(3)(C)(ii) limits the amount of indebtedness treated as home equity indebtedness to $100,000 ($50,000 for a married individual filing separately).

In the question above, it would be reasonable to conclude that interest on only $1,000,000 of the $1,200,000 mortgage would be deductible, because there is only acquisition indebtedness; there is no home equity debt. In two court cases — Pau v. Commissioner, T.C. Memo 1997-43 and Catalano v. Commissioner, T.C. Memo 2000-82 — the Tax Court embraced this exact theory, denying a taxpayer an interest deduction on their mortgage balance in excess of $1,000,000 when there was ONLY acquisition debt.

In Revenue Ruling 2010-25, however, the IRS announced that it would not follow the Tax Court’s decisions in Pau and Catalano. Instead, in the fact pattern above, the IRS will allow the taxpayer to treat the first $1,000,000 of mortgage debt as acquisition debt, and a second $100,000 piece of the same debt as home equity debt, even though it is simply an additional part of the original debt. The theory being that by definition, acquisition debt cannot exceed $1,000,000 for purposes of Section 163(h)(3)(B)(ii).

This means that the first $100,000 debt in excess of that amount satisfies all the requirements of home mortgage debt: it is secured by the residence, it is not acquisition debt, and it does not exceed the FMV of the home.

Thus, even though the taxpayer has only one mortgage with a balance of $1,200,000 that was used to acquire the property, only $1,000,000 is treated as mortgage debt, and the next $100,000 is treated as home equity debt. This gives the taxpayer an interest deduction on an additional $100,000 of debt than was given to the taxpayers in Pau and Catalano.

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Coming on the heels of my Friday post regarding the impending expiration of the COD exclusion for mortgages secured by a taxpayer’s primary residence, Roger McEowen of Iowa State University published this wonderful 5-page chart detailing 1) those provisions set to expire at 12.31.2012 as part of the sunset of the Bush tax cuts, 2) those provisions set to expire at 12.31.2012 unrelated to the Bush tax cuts and 3) those provisions that previously expired at 12.31.2011 and may be candidates for a Lazarus-like revival. With year-end planning just around the corner, it’s a must read.

Hat tip: Joe Kristan at Roth & Co.

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If you are one of the 97% of Americans whose home is worth significantly less than when they purchased it, you’ve likely been seeking out some type of debt modification with your lender. Or perhaps things have gotten so bad that you’re contemplating a foreclosure or short sale.

Here’s the thing: anytime a mortgage is modified (i.e., reduced), the borrower is required to recognize cancellation of indebtedness (COD) income under Section 61(a)(12). Similarly, if a property is sold at foreclosure or in a short sale and the underlying mortgage is recourse (meaning the borrower has personal responsibility for any excess loan deficiency remaining after the sale), then to the extent the remaining deficiency is forgiven, the borrower will again recognize COD income.

In the foreclosure or short sale context, this COD income is NOT treated as gain from the sale of the property, and thus is not eligible for exclusion under Section 121 (allowing a $500,000 exclusion for MFJ taxpayers who have owned/used the home as their principal residence for 2 of prior 5 years).

When the sh*t hit the fan in the real estate market in 2006 Congress recognized that something had to be done, as it seemed patently unfair to tax homeowners on COD income when they couldn’t even afford to service the underlying mortgage. And while exclusions to COD income have always existed under Section 108, prior to 2007 those exclusions were only of use to a homeowner if the homeowner were insolvent or bankrupt.

As a result, in 2007 Congress enacted Section 108(a)(1)(E), which provides that a taxpayer that is neither insolvent nor in bankruptcy can still exclude up to $2,000,000 of COD income related to the discharge (in whole or in part) of qualified principal residence indebtedness. This exclusion applies where a taxpayer restructures his or her acquisition debt on a principal residence, loses his or her principal residence in a foreclosure, or sells a principal residence in a short sale.

For these purposes:

  • Qualified principal residence indebtedness is debt that meets the Section 163(h)(3)(B) definition of acquisition indebtedness for the residential interest expense rules but only with respect to the taxpayer’s principal residence (i.e., does not include second homes or vacation homes), and with a $2 million limit ($1 million for married filing separate taxpayers) on the aggregate amount of debt that can be treated as qualified principal residence indebtedness.
  • Acquisition indebtedness includes refinanced debt to the extent the refinancing does not exceed the amount of the refinanced acquisition indebtedness.
  • For purposes of these rules, a principal residence has the same meaning as under the Section 121 home sale gain exclusion rules.

Why do you care? Because as of today, this exclusion is set to expire on December 31, 2012. That means you have to ask yourself: How much do you trust Congress to get an extension done before year end? If you do, then by all means, take your time with your debt modification/foreclosure/short sale efforts. But if you don’t, you might want to get a sense of urgency about getting something done with your bank prior to year end, so you can take advantage of Section 108(a)(1)(e) while it’s here.

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One of the most revealing aspects of using WordPress as a blog host is having the ability to track the different search engine terms that have ultimately led people to Double Taxation.

Through analyzing this data, I’ve realized two things:

1. There are some sick, sick people out there. To wit: the single-most common string of words that have led web users to this blog during its 18-month history is “power ranger porn.”  Sadly, I’m not making that up. Needless to say, when these deviants wound up getting this blog post instead of whatever depravity they were hoping for, they were more than a little let down.

2. People really want to know whether they can claim a tax deduction for mortgage interest they pay on a mortgage that’s not in their name. My previous discussion on the issue has been an oft-searched post, a result I attribute to our depressed economy. With banks having tightened their purse strings, many non-traditional arrangements for home ownership have sprung up. In many cases, the individual who owns the home and borrows the mortgage is not the same individual who lives in the home and pays the mortgage.

These arrangements are not unique to primary residences. Consider the case of Omar Abarca, a real estate investor who owned rental property through six partnerships. Because Abraca had limited borrowing capacity, each time he wished to purchase a rental property he would enter into a partnership; Abraca would contribute cash, while the other partner would use their borrowing ability to take out a mortgage and purchase the desired property. Abraca would then pay all the operating expenses of the property, including the mortgage interest.

It was unclear whether the borrowing partner ever actually contributed the title of the property to the partnership. What was clear, however, was that Abraca was never listed on the title for each property, nor was he listed as a lender. On his tax returns, Abraca failed to acknowledge the separate legal existence of the partnerships, opting instead to report the activity for each rental property directly on Schedule E, where he deducted the mortgage interest paid on behalf of each property.

The IRS challenged the deductions, asserting that because Abraca was neither the title holder nor the borrower on each property, he was not entitled to deduct the mortgage interest.

To support their position, the IRS cited I.R.C. § 163, which begins by providing the general rule that “There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.”  However, I.R.C. § 163 further provides that the indebtedness must be an obligation of the taxpayer, and not an obligation of another. An exception to the general rule that interest paid on an obligation of the taxpayer is deductible only by that taxpayer is found in Treas. Reg. §1.163-1(b), which provides in part that:

“Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.”

In summary, just as with primary residences, in order for an individual to deduct interest expense on a rental property he must be either:

1. named as a borrower on the mortgage, or

2. be either the legal owner or equitable owner of the property.

Because Abraca failed to establish that he met either test, the Tax Court sided with the IRS, holding that Abraca was not entitled to deduct any of the mortgage interest he paid on behalf of the rental properties.

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In a case with damaging implications for wealthy gay and unmarried couples, the Tax Court held yesterday that the $1,100,000 limitation on mortgage debt for purposes of determining deductible interest expense must be applied on a per-residence, rather than a per-taxpayer basis.

As we discussed in a previous post, I.R.C. § 163(h)(3) allows a deduction for qualified residence interest  on up to $1,000,000 of acquisition indebtedness and $100,000 of home equity indebtedness. Should your mortgage balance (or balances, since the mortgage interest deduction is permitted on up to two homes) exceed the statutory limitations, your mortgage interest deduction is limited to the amount applicable to only $1,100,000 worth of debt.

Now assume for a moment that you and your unmarried girlfriend/lifemate/Japanese body pillow go halfsies on your dream house, owning the home as joint tenants. And assume the total mortgage debt — including a home equity loan of $200,000 –is $2,200,000, with each of you paying interest on only your $1,100,000 share of the debt.

Are each of you entitled to a full mortgage deduction — since you each paid interest on only $1,100,000 of debt, the maximum allowable under Section 163 — or is your mortgage deduction limited because the total debt on the house exceeds the $1,100,000 statutory limitation?

The answer, according to the Tax Court, is the latter. In Sophy v. Commissioner, this issue was surprisingly addressed for the first time in the courts (it had previously been addressed with a similar conclusion in CCA 200911007), with the Tax Court holding that the $1,100,000 limitation must be applied on a per-residence basis.

Thus, in the above example, even though the joint tenants each paid mortgage interest on only the maximum allowable $1,100,000 of debt, each owner’s mortgage interest deduction is limited because the maximum amount of qualified residence debt on the house — regardless of the number of owners — is limited to $1,100,000. Assuming the joint tenants each paid $70,000 in interest, each owner’s limitation would be determined as follows:

$70,000 *  $1,100,000 (statutory limitation) = $35,000

                 $2,200,000 (total mortgage balance)

Instead of each owner being entitled to a full $70,000 interest deduction, the mortgage interest deduction is limited for both because the total debt on the house exceeds the statutory limits. The court reached this conclusion after examining the structure of the statute and determining that the plain language required the applicable debt limitation to be applied on a per-residence basis:

Qualified residence interest is defined as “any interest which is paid or accrued during the taxable year on acquisition indebtedness with respect to any qualified residence of the taxpayer, or home equity indebtedness with respect to any qualified residence of the taxpayer.” Sec. 163(h)(3)(A) (emphasis added).

The definitions of the terms “acquisition indebtedness” and “home equity indebtedness” establish that the indebtedness must be related to a qualified residence, and the repeated use of the phrases “with respect to a qualified residence” and “with respect to such residence” in the provisions discussed above focuses on the residence rather than the taxpayer.

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[Ed Note: This is the first of what will be a recurring series of posts by WS+B Tax Partner Steve Talkowsky addressing the seminal tax cases in our country’s tax history. Why do something like this?

Because unless you happen to be this chick, the tax law is considerably older than you are. As a result, no matter how diligent and dutiful you may be in absorbing current events, the reality is that much of the current law was established long before you were a twinkle in your daddy’s eyes.

To speed up your learning curve, Mr. Talkowsky will stop by from time to time to reintroduce and dissect those landmark decisions that have had a far-reaching impact on the tax law as we know it.

First up: The Supreme Court’s decision in CRANE v. COMMISSIONER. Now on to Steve…]

My esteemed colleague likes to blog about current events, but as they say, in order to understand the present you must understand the past.  So I have taken on the task of blogging about Crane v. Commissioner, 331 U.S. 1 (1947).

Crane is widely considered the landmark Supreme Court decision in the tax world, as it created the law we have today –  that if nonrecourse debt is assumed by a buyer upon a sale of property, that assumption is equivalent to receiving cash proceeds by the seller and must be used in the calculation of taxable gain or loss.

Mrs. Crane (Crane) inherited all of her husband’s property upon his death; unfortunately, she also inherited all of his debt as well.  At this time of his death, the building’s FMV and related mortgage were as follows:

FMV: $262,000

Mortgage: $262,000

Equity: $0

The mortgage was nonrecourse – meaning that if Crane could not pay the mortgage, the building could be used to satisfy the mortgage but the lender could not go after Crane’s other assets.

Crane could not keep up the building and the mortgage went into default. In order to avoid foreclosure, Mrs. Crane sold the building for $2,500 in cash plus an assumption of the mortgage balance of $255,000 by the purchaser.

Mrs. Crane —  taking a rational, non-tax approach —  reported gain of $2,500 on her tax return.  In her mind, when she inherited the property from her husband, her basis in the property was $0, as the mortgage fully offset the FMV of the property. In other words, she viewed the value of the property as being synonymous with her equity in the property. Because Crane believed she had no basis in the property, she took no depreciation, and the sale of the property for $2,500 generated gain of $2,500 ($2,500-$0).

The IRS disagreed, arguing that:

1. Crane’s basis in the inherited property was the FMV of the property of $262,000, rather than the net equity of $0. The Service then reduced her basis by $28,000 of allowable depreciation to come to a net adjusted basis of $234,000; and

2. Crane’s proceeds from the sale of the property included not only the $2,500 of cash received, but also the relief of the $255,000 nonrecourse mortgage assumed by the buyer, for a total sales price of $257,500.
Thus, according to the IRS, Crane recognized a gain of $23,500 on the sale of the property ($257,500 – $234,000).

The Tax Court decided both issues in favor of Crane, but the Second Circuit Court of Appeals reversed the decision. In its seminal decision,  the Supreme Court  sided with the IRS and affirmed the Appellate Court  with a 6-3 decision, establishing two fundamentals of tax law in the process:

1. When basis is determined in reference to the “fair market value of the property” — as it is in the case of an inheritance under I.R.C. § 1014 — the word “property” refers to the actual physical object being acquired, not the net equity of the object being acquired; and more importantly,

2. Even when a taxpayer is not personally liable on a debt — as is the case with a nonrecourse mortgage — the amount realized upon any sale or disposition of the mortgaged property must include any portion of the nonrecourse debt that is assumed by the buyer.  The Supreme Court reasoned that the economics were no different than if the buyer had simply paid cash equal to the mortgage balance to the seller who used the proceeds to pay off the mortgage simultaneous to the sale. While a litany of cases had already established this to be the case when the borrower was personally liable on a debt or mortgage (i.e., recourse debt), this was an issue of first impression with regards to nonrecourse debt.

[Ed note: For a case with a very basic, understandable set of facts, Crane has grown into the most impactful tax case ever decided by the Supreme Court.  It spawned widespread abuses during the tax-shelter era of the 80’s by allowing a taxpayer to take depreciation deductions on the cost of acquired property — unreduced by any debt encumbering the property. To understand how, consider this: the Crane decision permitted a taxpayer to borrow $100,000 from a bank on a nonrecourse basis and then acquire and depreciate machinery, even though the taxpayer’s economic investment in the acquired machinery was $0 ($100,000 cost – $100,000 debt). Smart, inventive people looking to save on taxes can do wonders with facts like that.

Crane also indirectly gave birth to the passive activity rules, as they were largely enacted to curb these abusive tax shelters. In turn, the passive activity rules played a large role in the savings and loan crisis of the late 1980’s.

More recently, Crane has returned to the public consciousness with the string of real estate foreclosures that have defined the previous half decade. The economic downturn has left many taxpayers unable to pay their mortgages. In situations where those mortgages are nonrecourse, a transfer of the property by the borrower to the lender in lieu of foreclosure and in satisfaction of the nonrecourse mortgage is treated as a sale of the property for the amount of the nonrecourse mortgage under the principles established 60 years ago by the Supreme Court in Crane.]

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