After the Pain of Foreclosure, a Big Tax Bill

[RamboLiberal]

Source: NY Times

Two years ago, William Stout lost his home in Allentown, Pa., to foreclosure when he could no longer make the payments on his $106,000 mortgage. Wells Fargo offered the two-bedroom house for sale on the courthouse steps. No bidders came forward. So Wells Fargo bought it for $1, county records show.

Despite the setback, Mr. Stout was relieved that his debt was wiped clean and he could make a new start. He married and moved in with his wife, Denise.

But on July 9, they received a bill from the Internal Revenue Service for $34,603 in back taxes. The letter explained that the debt canceled by Wells Fargo upon foreclosure was subject to income taxes, as well as penalties and late fees. The couple had a month to challenge the charges.

For those who struggle to pay their bills, who watch their housing payments rise out of reach with their adjustable-rate mortgages, who lose a job or who fall victim to illness, losing one’s home can feel like hitting bottom. But one more financial indignity may await as the fallout from the great housing boom ripples across the United States.

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The 1099 shortfall, as it is called, stems from an Internal Revenue Service policy that treats forgiven debt of all types as income even if the taxpayer has nothing tangible to show for it, unless the debt is canceled through bankruptcy.

Read more: http://www.nytimes.com/2007/08/20/business/20taxes.html?hp

[onewholaughsatfools]

1. well as i see it, paying taxes

to over expose myself, I was approached by irs three times, until i stopped paying taxes, now for 20 years i have not been visited by the irs, they are simply a collecting company not a government inity.......

[1932]

2. "inity"?

[Name removed]

4. Deleted message

Message removed by moderator. Click here to review the message board rules.

[cliss]

3. Wow. That's completely disgusting.

He loses his home, Wells Fargo walks away with the goods. And he gets stuck with the tax bill?

[Vinca]

5. This is outrageous. Congress needs to change this ASAP.

If a person loses real estate when a debt is forgiven, they are - the majority of the time - losing lots and lots of money. It's not "income" by any stretch of the imagination. The IRS goes after poor people because they're easy pickins. If you can't pay a mortgage, you can't afford a tax attorney.

[1932]

6. Check this out: Edwards's plan

http://www.democraticunderground.com/discuss/duboard.php?az=show_mesg&forum=132&topic_id=3460358&mesg_id=3460550

Incidentally, I think it's very important that commercial loans are subject to this rule (otherwise lending would be a way to give people a lot of money tax free). But it is the truth that this is going to hurt a lot of mortgage holders.

[melm00se]

7. parts of this article smell

at foreclosure sales, bid their "upset" amount; that is to say that the opening bid by the foreclosing lender is the based upon the outstanding mortgage balance (principle, earned interest, unpaid late fees and legal fees). So if the borrower owes $106K, the lender normally will bid $106K (and bidding above that amount is, in almost, if not all states, illegal) and anyone who wants the house has to bid above that amount.

failing a superior bid, the lender then becomes the titled owner of the property (and a "paper" title transfer occurs, hence the $1 "sale" price) and the house becomes "REO" (real estate owned) property. At this point, the lender will list the property with a real estate agent and attempt to sell the house for the best price possible. Having been involved in many foreclosures, I have never had an REO property go for more than the loan balance + costs (and the law requires a complete and accurate accounting of fees and legally defines what fees are acceptable and which are not). The expected sale price is approximately 80% of the appraised market value as a foreclosure sale/foreclosed property is considered a distressed property sale.

While the attorney is correct in saying that the lender has some leeway in how to value the property, the issue may be (and is not addressed here) is the loan was covered by PMI and at the point, failing to value the property correctly could jeopardize the lenders ability to file and collect on the insurance policy.

The article makes it appear (a) that the 1099 shortfall is a "new" thing and that (b) many, if not all, foreclosures will be affected by this. In the former, the 1099 debt forgiveness provision has been in place since the early 90's and in the latter, the vast majority of foreclosures are preceded or followed by a bankruptcy filing thus eliminating this tax liability. Any attorney worth his salt would have advised his client that a bankruptcy filing is almost always recommended when faced with a primary residence foreclosure.

One other part that is questionable is the assumption that a private appraisal would/should match the county tax valuation. Unless the county does annual assessments (extremely rare) and those assessments are 100% assessments (also not common), it is unlikely that the 2 amounts match (I know that in the 3 houses I have owned, the valuations only matched at the time of sale - property appreciation took care of that within the 1st 12 to 18 months. even when the property was reassessed, it wasn't accurate...the assessment took place in the spring and the valuation took effect the following spring - - there was 12 months from the 2 events).

[slackmaster]

8. Sounds like a good time for the Stouts to consider filing for bankruptcy

:shrug:

[kurtyboy]

9. Good IRS code, but Wells Fargo may be tax evaders

The code the IRS employs is in place to capture taxes on income--

Wells Fargo sent the 1099-C because they knew they could claim a loss of $105,999 (value of the loan minus one dollar), carving out a nice chunk of change on their taxable income. But, they cannot make the claim unless they file the loss--1099 to both the IRS and the forgiven debtor. (BTW, banks will often bid trivial amounts on forclosure sales when there are no bidders as a way to avoid percentage-based transfer costs)

When they sold the property at the full value of the written-off loss, it was incumbent upon them to amend their return to show the loss had been recovered. It seems from the article as though they neglected to do so, until the reporter began making the calls. They are not being the good guys here--they might even have been gaming the system.

As for the code itself, I think it is good. There are gojillion loans out there where speculators have purchased with the only hope of repayment coming in a rising market. These speculators (I can think of less kind names for them...) often never even live in the homes, sometimes never even see the home in person. While the home sits unoccupied, or is occupied by renters paying a fraction of the carrying costs, prices of all homes are driven up by scarcity. Even more speculators enter the market, and the cycle becomes exponential.

Meanwhile, REAL potential homeowners, with the drive to own and the committment to pay, cannot enter the market because of the high pricing.

Now, the market is in it's inevitable decline, and speculator after speculator is defaulting on loans that had littl or no down payment. They only disincentive left for these capitalists is the tax bill. If their 1099-C "gains" are not taxed, as some posters seem to think would be prudent, then these speculators will have suffered no penalty whatsoever for tying up housing that ought to have been used and owned by decent, hard-working Americans. The term for all of this is "market-failure", and capitalism is chock full of it.

While the people in the article who lost their home were not speculators of the sort I have pointed out here, I note that they were also able to get the IRS to see things their way. Insolvency is a solid defence--but speculators ought to be taken to the woodshed before they are able to use it.

EDIT to add:

I think a huge number of lenders got caught up in the speculation as well, and left prudence out of many of their lending decisions. They, too, must pay a price for their actions. Perhaps the losses and declining stock valutions are sufficient, or perhaps they should only be able take a portion of the loss for taxation purposes. I don't know.

One thing is clear, we would have not to be considering any of this if the government had been doing its job for the last 27 years. You can chalk all of this up to Reagan's revolution that said "Government IS the problem." Shoddy regulation= S&L bailout, LTGM crisis, and the housing bubble meltdown.

Too late now.