A Minor's Taxable Income; Deductions for a Third Home and Taxation on Foreclosure

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, October 4, 1998

Copyright 1998 Robert L. Sommers, all rights reserved.

Question: My 2-year-old made $20,000 working as a model, has no itemized deductions and received $2,000 in interest income. How is she taxed?

A: She pays tax on her earned income as an individual. She is entitled to a standard deduction (maximum of $4,250 in 1998), but not a personal exemption, if she is eligible to be a dependant on an adult's return. Because your child earned more than $4,250, she is entitled to the full standard deduction. The balance of $15,750 ($20,000 minus $4,250) is taxed by the federal government at a 15 percent rate.

The first $700 of her interest income is taxed at her income tax rate, the balance generally at your highest tax rate. This rule applies to all children still under age 14 by the end of the year. Therefore, if your highest rate is 28 percent, $700 is taxed at 15 percent and the remaining $1,300 at 28 percent.

Question: May I deduct real estate taxes and mortgage interest on a third home?

Answer: Yes and no. Real estate taxes may be deducted as an itemized deduction without limitation. Mortgage interest deduction is restricted to debt secured by first and second homes. Also, the mortgage interest deduction is limited to acquisition debt (debt incurred for acquiring, constructing or substantially improving the home) not exceeding $1 million. In addition, you may deduct the interest on home equity loans secured by a first or second home to a maximum debt of $100,000.

Question:  I have been unable to sell the rental property I purchased in 1994, which has a current fair market value of $90,000, adjusted basis of $80,000 and a recourse loan (I am personally liable for the repayment) with a balance of $110,000. If the lender forecloses in full satisfaction of its debt, will I owe tax?

Answer: Yes. You are treated as selling your property at the fair market value of $90,000 and will have a $10,000 capital gain (the $90,000 fair market value minus the $80,000 adjusted basis). The $20,000 balance (the $110,000 recourse debt minus the $90,000 fair market value) is considered ordinary income from the cancellation of debt.

The federal government will tax your $10,000 capital gain at a 25 percent rate to the extent of depreciation and the balance is taxed at a 20 percent rate. California taxes capital gains at ordinary income rates.

Your $20,000 income from the cancellation of the debt is usually taxed at ordinary income tax rates, but is excludible if:

*You are insolvent when the foreclosure occurs;

*The debt is discharged in bankruptcy under Title 11 of the U.S. Code; or

*The property is "qualified real property indebtedness."

In your case, the insolvency or qualified real property indebtedness exceptions could apply.

Note: If the loan was non-recourse (you were not personally liable for the repayment), the property is considered sold for the debt amount $110,000 and your capital gain would be $30,000 (the $110,000 loan balance minus the $80,000 adjusted basis). Cancellation of debt rules do not apply to non-recourse sales.


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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**