More and more Americans are finding themselves in a position they hoped would never be. Financial problems or life changes coupled with owning homes that are worth far less than the mortgages that secure them have caused many to decide the only option is to sell their homes for less than they owe (a Short sale) or to walk away all together and let their homes go into foreclosure.

One thing many of these individuals are not aware of as they analyze there situation: The potentially significant tax consequences associated with the debt forgiven or possible capital gain in either a short sale or a foreclosure. The following is an overview of some of the important tax implications anyone considering a short sale or foreclosure should be aware of.

Potential Capital Gain on Sale:

This is less of an issue with primary residence sales but can really cause issues with highly leveraged investment properties and so is worth noting here.  Your tax basis in your property is what you purchased your home for plus any major capital improvements less depreciation expense taken, if applicable. In a short sale the purchase price is always less than your mortgage debt outstanding but it can still be higher than your original purchase price. To the extent the sales price exceeds your tax basis (purchase price plus improvements minus depreciation) there will be a taxable gain. There is a common misconception that somehow your mortgage balance is a factor in calculating the basis of your property – it simply does not factor into basis calculations in any way! With primary residence transactions this gain is excluded up to $250,000 (or $500,000 Married Filing Joint) if homeowner has lived in the home, as their primary residence, 2 of previous 5 years. Because of this §121 Gain Exclusion homeowners often side step this potential hit. That said no exclusion exists for investment properties, second homes or primary residences that do not qualify for 2 of 5 year rule. Although the scope is limited this is a real issue that we are seeing show up and should be thought through before making any final decisions.

DDI Debt Discharge Income:

DDI is the big one for individuals to understand. Individuals must understand how these rules pertain to their specific situation before making any final decisions on property transactions.

In 2007 congress passed a bill allowing up to $2,000,000 of DDI from mortgage debt to be tax free when debt was taken out to acquire, improve or build an individual’s principal residence. This does not include debt created through a cash-out refinance or home equity line that was not used to improve your principal residence. Taxpayers must be prepared to trace any increase in principal during the period of homeownership to building or improvements or those portions of the overall mortgage debt will NOT be tax free. If the taxpayer has potential exposure after this analysis there may still be hope for tax free treatment. If the taxpayer is going through bankruptcy when the debt discharge transaction occurs it will be tax free OR if the taxpayer can show they are insolvent they will be able to treat the DDI as tax free income. Also worth noting is that the 2007 provision does not include investment properties or second homes making DDI associated with these properties taxable unless you are going through bankruptcy or are insolvent. Insolvency calculations can be subjective and complicated so taxpayers should consult a tax professional before attempting to go down that path.

DDI Example: Mr. D purchased a $300,000 home in 2003 and took out a $240,000 interest only mortgage in order to acquire this home. In 2006 Mr. D’s home was appraised at $400,000 and he did a refinance to lower his rate and take some cash out with new principal balance of $300,000. He used the $60,000 he received at closing to buy a new boat and car. Later in 2006, Mr. D took out a HELOC of $100,000 to invest in a business opportunity bringing total debt on this property to $400,000 (100% of 2006 appraised value). He assumed his house would be worth $500,000 in a couple years and he would again have 20% equity. In early 2009, Mr. D lost his job and fell behind on his monthly mortgage payments. He realized his house was now worth closer to $250,000 when his neighbor sold her house for that amount. Then after 9 months without finding work he was so far behind on his payments and so frustrated that his once $400,000 home was now worth closer to $250,000 that he walked away from his property to rent an apartment. When he went to his accountant get his taxes done for 2009 he was told he had $160,000 of debt forgiveness income to claim on his return from the $60,000 taken on refinance and the $100,000 from HELOC, neither of which was used to improve his property. This DDI caused a $50,000 IRS bill that MR. D had no idea was coming. Mr. D was not in bankruptcy and although cash was tight he had assets on his personal balance sheet making it impossible to claim insolvency. In the end this debt forgiveness income was taxable income and he was on the hook for a significant tax bill.

Short Sale Gain Example: Using the same facts as above except for this was Mr. D’s lake home and not his primary residence plus rather than foreclosure he made Short Sale for $350,000. Mr. D is going to have $50,000 of DDI when he is off the hook for $50,000 of total $400,000 of mortgage debt. PLUS he will have a capital gain on the sale of this property calculated as follows.

Proceeds: $350,000
Tax Basis: ($300,000) Purchase Price – no major capital improvements
Gain on Sale: $50,000

Although he nets zero and has $50,000 taxable debt forgiveness income his second home still creates a taxable capital gain of $50,000. Total income to report on his 2009 tax return related to disposal of second home is $100,000.

Whether it is you, a client of yours, or a personal contact of yours make sure people forced to make these tough decisions consult a tax professional in advance. Most people will not have these issues given the taxpayer friendly legislation that has passed but some will start to take a sigh of relief only to have IRS piling on new financial problems immediately following.

Held on Saturday, April 24th at Park Glen Apartments, Splash Day raised money for the Susan G Komen for the Cure. Many guests walked away with some great silent auction items. Thanks to some other great sponsors and the attendees of Splash Day, Park Glen Apartments was able to raise $2,200 for the MN Chapter of Susan G Komen for the Cure.

In addition, Envy nightclub held a Splash Day After party which also contributed half the money collected at the door to Susan G Komen for the Cure. The Loop Bar & Restaurant donated everyone’s first drink to the charity on April 29th. Together, these additional events raised over $500!

Hope to see some more familiar faces at next years event!

Less Than Two Weeks Left
First Time and Repeat Home Buyer Tax Credit opportunity scheduled to end April 30th 2010. There is still time to take advantage of this opportunity! All purchase agreements need to be signed an finalized by this date however closings need only to occur before June 30th 2010. Good luck and make sure to consult with your tax advisor or accountant as to which deductions are applicable to your particular circumstance. A few key points can be found at the Federal Housing Credit web site.

Skyscape Two Bedroom Corner Unit

Skyscape in Downtown Minneapolis. Upper floor unit with two bedrooms, two bathrooms, den / home office and a generous walk in closet. This corner home is wrapped in glass, has great skyline views and boasts two balconies. Open floorplan is great for entertaining. 1,366 finished square feet.

Price: $375,000

929 Portland Avenue South #2410, Minneapolis, MN 55404

River Station – 2 level condo

Fantastic multi-level, walkout unit near the new Twins Ballpark. Well cared for home in great condition. Light, bright and tastefully decorated throughout. Private raised/gated patio. Extremely convenient location close to parks, the river, shopping, restaurants and more.

Price: $238,000

645 North 1st Street #133, Minneapolis, MN 55401

Palms Place 35th Floor Oasis in Las Vegas

Fully furnished 1220 square feet suite in Palms Place. Contemporary features with extraordinary strip views from this 35th floor wraparound balcony. Palms Place Hotel & Spa goes beyond what you’ve come to expect from a Las Vegas hotel. Whether you choose to unwind with a drink in the chic lobby bar, Rojo, enjoy delectable bites at Kerry Simon’s, Simon at Palms Place, or experience a unique treatment at Drift Spa you will think you went to heaven. There is even a SkyTube that connects you to 24-hour action at Palms Casino Resort.

Listing courtesy of Elle Gaensslen

Price: $950,000

4381 West Flamingo #35302, Las Vegas, NV 89103

Oversized Uptown Upper Level Duplex

Rental Property Available June 1
This 1482 sq foot unit features a built-in buffet, fireplace and an updates kitchen. Natural woodwork and hardwood floors. Pet’s negotiable. 1 Garage stall included plus other parking. There is a large shared storage area and laundry space in lower level. Tenant is responsible for gas and electricity. Water, garbage and sewer are included in rent.

Price: $1,275/mo

3733 Lyndale Avenue South, Minneapolis, MN 55409

You can find the answer within the Living in the City pages.

To submit your answer for a chance to win 2 tickets to the Walker, leave your guess as a comment to this blog post.

Winner will be chosen at random from correct submissions and announced, via Twitter, Monday afternoon, April 26th.

Moving to a new city is exciting. But it can also be confusing and intimidating. Well, take a deep breath and relax. As a long time Realtor licensed in multiple states and supported by a network of affiliates around the globe – I can assist you here, there or anywhere! My job is not only to aid you in finding a home, but also to make you feel comfortable once you get here. I can help you discover where to live (temporarily and permanently), where to shop, where to eat, where to go, what to do, how to set up your utilities, etc. In future months we will start to showcase the listings of some of our global real estate partners… Enjoy and let me know how I can help!

The Historic Bellevue Condominiums

Beautiful corner unit with Private Balcony. 12′ Ceilings, New Windows, Central Air, Hardwood Floors and more. Master bedroom with new carpet and full private bath. 2nd bedroom with full wall of built-ins could also make a fantastic den or home office. Historical splendor in the heart of the city! Located at the corner of Hennepin and 13th.

Price: $250,000

1227 Hennepin Avenue #3C, Minneapolis, MN 55403

Immaculate York Avenue Condo

One of the best homes you will see. Not a short sale or foreclosure. A well priced unit in a great complex. Close to everything and so much on site…

This home is immaculate! You won’t be disappointed with this extra clean two bedroom, two bath unit close to parks, shopping restaurants and more. Community hosts a fantastic array of amenities. Don’t miss this one.

Price: $138,000

7200 York Avenue South #106, Edina, MN 55435

Right off Minnehaha Creek

Rental Property
Three bed, two bath, 1,300 finished square feet PLUS basement laundry/storage space. Available Immediately. Updated bungalow one block from Minnehaha creek and parkway. Highly desired location with easy access to both downtowns and southern suburbs. Charm, character and lots of space. Much larger than it looks from the exterior. All appliances included. tenants responsible for mowing and snow removal.

Price: $1,450/mo + utilities

4844 14th Avenue South, Minneapolis, MN 55417

Experience Las Vegas

Vdara, Aria and Harmon are the hottest and newest hotel and condominium units available in City Center. From studios homes to extravagant penthouses, this LEED Gold certified complex in the heart of Las Vegas has something for everyone seeking to own their own luxurious piece of the strip. Escorted tours available upon request.

City Center, Las Vegas, NV

Test Your Social Knowledge?

Who were the Pritzker Prize-winning architects who designed Walker Art Center’s restaurant 20.21?

You can find the answer within the Living in the City pages.

To submit your answer for a chance to win a $50 gift certificate to 20.21, leave your guess as a comment to this post.

Winner will be chosen at random from correct submissions and announced, via Twitter, Monday afternoon, April 12th.