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The Tax Prophet Newsletter   Issue # 54 October, 2007

REDUCE TAXES!
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In This Issue:
Introduction
COD Income
Insolvency
Fixing the Problem


Tax Consequences of
Mortgage Foreclosures


Introduction

Ouch! Your lender just foreclosed on your principal residence and, suddenly, you have taxable income stemming from the loss of your home - huh?

Welcome to the looming tax crisis facing borrowers arising from the residential housing collapse, caused in large part by sub-prime loans.

COD Income

Buried in the tax code is the concept called cancellation of debt ("COD") income. Although the variations involving COD income can be mind-numbing, it basically works like this:

Example: Suppose you owe $1,000 and your only asset is $1,000 in a bank account. If you compromise your debt by paying $400, you have "freed up" $600 of your assets ($1,000 in the bank less the $400 paid to the lender). You have $600 of COD income.


Insolvency

In the above example, suppose you owed $2,000 and the lender compromised the debt for $1,000. In this case, after paying the compromised debt with the $1,000 in your bank account, you are insolvent (you have no positive net worth). Since none of your assets have been freed up, the insolvency exception to the COD income rule applies.

Unfortunately, the insolvency exception is complicated and requires valuing your net worth before and after the discharge of debt. Worse, the lender reports the entire $1,000 of debt relief to IRS (Form 1099-C) and you must claim the insolvency exception on your tax return.


Fixing the Problem

Congress is considering fixing the COD issue involving debt used to purchase a residence (HR 3645). The potential fix should eliminate qualified residence indebtedness from the COD rules. However, Congress is leery of those with substantial net worth using the new law to escape COD income, so expect the final version to be complicated.



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All contents copyright 2007 Robert L. Sommers, attorney-at-law. All rights reserved. This newsletter provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet is a registered trademark of Robert L. Sommers.