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March 1, 2010

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This month, Small Business Tax News returns with some questions from readers and some answers from our editors.

Dear SBTN,

I purchased a new home late last year and am unsure if I can qualify for the $6,500 tax credit for existing homeowners that buy a new home. I closed on the home on Nov. 2, 2009. I couldn’t delay the closing any longer, but, as luck would have it, the eligibility for the credit runs from Nov. 7 until April 30 next year. Is there any leeway on this closing date?

Thanks,
Brian from New Jersey

Dear Brian,

Unfortunately, these dates are set in the legislation and not flexible. Last year’s legislation expanded the first-time homebuyer tax credit to grant up to $6,500 credit to current homeowners purchasing a new or existing home between Nov. 7, 2009, and April 30, 2010.

A source in Sen. Chris Dodd’s office said, you can qualify for the credit even if you signed a purchase contract before Nov. 7, but the important thing is that you close on the home between Nov. 7 and June 30, 2010 (your contract must be signed by April 30, 2010).

Dear SBTN,

I am a young investor owing mortgages on my two properties that are nearly double the actual market value. Bank of America and Litton Loan Servicing are the two mortgage holders, and I have owned the properties for about seven years. The two properties have been on the market for over six months, with multiple price reductions, and finally I have found buyers for each property.

There is no doubt that an appraisal will justify the contract prices and confirm that any previous appraisals were falsified when I applied for the mortgage refinances. However, I am being told that my tax consequences would be so high that I am better off filing bankruptcy and letting the banks foreclose. With an adjusted gross income of about $36,000 and no other properties owned, what advice can you offer?
Thanks,
Anonymous

Dear Anonymous,

Unfortunately, the tax consequences of doing a short sale on investor properties are very onerous. Under federal law, the investor/borrower would have to pay a hefty tax – probably at a 28 percent tax rate – on any debt forgiveness associated with a short sale. However, if you were to accept the deficiency with a short sale, there wouldn’t be any tax liability.

Accepting the deficiency with a short sale may be preferable to a foreclosure if the banks have little chance in actually collecting on the deficiency. This might be the least damaging event in terms of your credit.

In terms of bankruptcy, the borrower/investor can theoretically get a judge to “cram down” his investor mortgages to their current market value and wipe out any remaining debt. You could then look to do a short sale with the banks to unload the properties and completely discharge the remaining debt.

The downside to a bankruptcy is that it will really damage your credit score for at least five years. Before you consider any action, talk with an attorney to better weigh all of these options.

--The Editors at Small Business Tax News