IRS pursues ex-homeowners who didn’t qualify for break

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IRS pursues ex-homeowners who didn’tqualify for break

Income exemption on mortgage forgiveness had many exceptions

Premium content from Sacramento Business Journal by Mark Anderson, StaffWriter

Date: Friday, January 27, 2012, 3:00am PST

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Banking & Financial Services, Residential Real Estate, Sacramento, Roseville, Granite Bay,Accounting & Consulting

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Sacramento-area accountants say they are seeing a new kind of housing hangover: IRS lettersseeking back taxes from homeowners who benefited from short sales, loan modifications andforeclosures.

A lot of folks struggling with underwater homes sold them and assumed they were covered bya temporary law that allowed tax-free mortgage debt forgiveness. But it turns out that somewho did not qualify for the tax relief took it anyway.

Accountants say they are seeing the problems starting to surface now as people are gettingletters from the Internal Revenue Service. And in many cases, those letters from the IRSare bills for taxes owed on unclaimed income.

“We are seeing and I am hearing about people who are shocked that they may owe tax on debtthey thought had been forgiven,” said Donna Sauter, partner and tax principal at Ueltzen &Co. LLP in Sacramento.

The Mortgage Forgiveness Debt Relief Act of 2007 offered relief to victims of the unfoldingmortgage crisis. It expires at the end of this year.



The act allows taxpayers to exclude from their income the amount of mortgage forgivenessthey get in a foreclosure, debt modification or short sale. But there are exceptions — lots ofexceptions. The relevant IRS publication runs more than 20 pages.

The law allows a tax exemption only for mortgage debt forgiveness on the original mortgage toacquire the property or for a second mortgage that was principally used for substantialimprovements on the property, such as a new roof or an addition.

A lot of people missed that “original loan” qualification requirement to use the exception,Sauter said.

People who refinanced the original purchase loan — or people who took out an equity loan forsomething other than home improvement — may not be eligible for the tax break.

And even families who used a refinance to do home improvements may have to show receiptsfor that work. Also, the debt relief only applies to a primary personal residence, and not anykind of secondary or income property.

Some of the IRS letters just seek more information to see if a homeowner qualified for the taxexception and to prove it. Others assess income tax on the forgiven debt, along with a penaltyand accrued interest, Sauter said.

Finding out they may owe money is a second blow for people who already lost a home, shesaid. “They think they qualified for all these exceptions, and they didn’t.”

In many cases, the people now seeking help from a tax accountant didn’t do so when they weregoing through the short sale or foreclosure, often because they were short of money then,Sauter said.

All too often, people take tax advice from a mortgage broker, a real estate agent or a relative,said Fred Crooks, a principal with CPA Corp. in Granite Bay.

“Not to throw real estate agents under the bus, but they don’t know that they don’t know whatthey don’t know about tax law,” said Steve McCormick, a partner with Scott & Baldwin CPAsCorp. in Roseville.

People who should have claimed the forgiven debt as income but did not claim it tend to findout their error several years down the line.

In some cases, taxpayers failed to recognize that the forgiveness was taxable because theyreceived an IRS 1099 form from their bank late or not at all. The lender is required to send theform to the borrower’s last known address, but that may be the home the borrower left after ashort sale, McCormick said.

The IRS gets a notice from the lenders who issue a 1099 to a borrower, and the IRS will noticethat a taxpayer didn’t report it, said Jesse Weller, spokesman with the IRS in Oakland.

“Good record-keeping is essential,” he said.

Mark Anderson covers banking, finance, accounting, technology, telecom, venture



capital, hospitality, tourism and restaurants for the Sacramento Business Journal.

IRS pursues ex-homeowners who didn’t qualify for break

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