Consider mortgage consequences when adding person to title
Upon mother’s death, tough choice must be made
February 28, 2012
By Benny Kass
DEAR BENNY: My mother has a reverse mortgage on her home, taken out after my father died. As the survivor, her name alone was on the title. The usual terms of the reverse mortgage apply, including the acceleration clause upon death or removal from the home.
If anyone else is added to the title via a quitclaim deed in a “tenancy in common,” what, if any, impact does that have on the loan terms? –K.G.
DEAR K.G.: Yours is an interesting question, and I am not sure of the answer. However, your mother signed a legal document whereby she agreed that on her death — or if she moved out of the house — the entire loan would become due and payable. That document was recorded among the land records in the county where the property is located.
Accordingly, if after signing that document she adds your name to the title, you are still bound by the earlier-recorded reverse mortgage.
So, your mother can add others to the title, but on her death — or if she moves out — the loan becomes due.
As a practical matter, the lender is interested only in getting paid. So, if you can refinance or somehow come up with the money to pay off the reverse mortgage, that would resolve the problem, and title would be as your mother wanted.
To be on the safe side, however, I would discuss this with the mortgage lender and try to get any approval in writing.
DEAR BENNY: Congress passed a law exempting from federal income taxes losses caused by home foreclosure and allowed banks to write down such losses. If the bank writes down the loss, it cannot at a later date choose to sue for the deficiency. At least that’s what our congressman told us at a town hall meeting. Is this correct? –T.C.
DEAR T.C.: Your congressman is correct on the law, but many banks are not following the law. If this is your principal residence — the home in which you live most of the year, vote and pay taxes on — and if the money you borrowed was used to buy, build or substantially improve that home, you will not have to pay any income tax on the debt that was forgiven by your lender.
This is a departure from the general rule that requires debtors to report all forgiven debt as ordinary income — see Section 61(a)(12) of the Internal Revenue Code. Up until the so-called “mortgage meltdown” occurred, there were only two exceptions to this rule that impacted residential homeowners.
If your debt was discharged by a bankruptcy court, or if you are insolvent, you were not obligated to pay any tax in this canceled debt.
However, when thousands of homes across the country began to be foreclosed upon, Congress amended the law. For debts forgiven in calendar years 2007 through 2012, up to $2 million of forgiven debt can be excluded from the obligation to pay income tax ($1 million if married filing separately).
And according to Julian Block, a prominent tax attorney, even if you are a single taxpayer, you still can exclude the full $2 million. Furthermore, the exclusion applies to all years, and not just for one.
This is an interesting loophole in the law. If you own more than one home that is “underwater” — i.e. the mortgage exceeds the fair market value of the house — you can claim the exclusion only for your principal house.
If that house is foreclosed upon (or sold via a short sale), nothing prohibits you from moving into your second home, establishing it as your new principal residence, and so long as your total losses do not exceed the statutory cap of $2 million, you can also sell that house at a short sale (or let it go to foreclosure) and not be required to pay any income tax on the canceled debt.
Of course, when dealing with the Internal Revenue Service, nothing is easy. The law does not apply to all forgiven or canceled debt. So your vacation home, your car loan or your credit card debt that is canceled will not qualify for the exclusion, unless you are insolvent or file for bankruptcy relief.
As mentioned earlier, the debt has to be used to buy, build or substantially improve your home. This is called the “qualified principal residence indebtedness” (QPRI). According to the IRS, “debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.”
Let’s use this example:
Becky purchased her home in 2002 for $315,000 and obtained a $300,000 mortgage. A year later she got a second mortgage in the amount of $50,000, from which moneys were used to add a garage to her house.
In 2008, when the outstanding balance of those two loans was down to $325,000, Becky obtained a new loan of $400,000. For tax purposes, her QPRI was $325,000. She used the additional $75,000 ($400,000 minus $325,000) to pay off personal credit cards and to pay her daughter’s college tuition.
She sold her house under a short sale for $300,000. The new lender forgave $100,000. However, under the new law, she can exclude only $25,000 ($100,000 canceled debt minus the $75,000 that was not QPRI). To add insult to injury, unless Becky files for bankruptcy relief or can claim insolvency, she will have to pay ordinary income tax on the $75,000 that cannot be excluded.
Had Becky used the refinance proceeds to substantially improve her home, she would have been able to exclude more of the canceled debt.
How is this handled when filing your next income tax return? First, if your debt is reduced or eliminated, your lender must send you Form 1099-C: Cancellation of Debt). By law, this form must show the amount of debt forgiven and the fair market value of any property given up through foreclosure or a short sale.
If you are in this situation, make sure that the information provided on the form is accurate; keep in mind that the IRS will get a copy of this form also.
If you qualify for the exclusion, you must complete Form 982: Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return. If you do not qualify, the canceled debt shown on the lender’s form is treated as ordinary income, for which you will have to pay the appropriate tax.
This is extremely complicated, and especially hard on consumers who have lost their family home. For more information, the IRS has issued Publication 4681, entitled “Canceled Debts, Foreclosures, Repossessions and Abandonments.”
But, despite the law and the fact that lenders send the IRS and the former homeowner Form 1099-C, many lenders have sold the deficiency to collection companies for pennies on the dollar. And these collection companies are hounding consumers for these dollars. I don’t know if there is litigation in this area, but there should be.
However, if you are involved in a cancellation of debt, get an attorney to assist you to assure, if possible, that you will not have to pay any deficiency.
DEAR BENNY: My mother and father have lived together for 38 years but were never married. The house is in my father’s name only and is not paid off yet. Will the mortgage company make her move? He left a will and willed her the house. –Helena
DEAR HELENA: First, if your father is competent to make decisions, why doesn’t he consider (1) marrying your mother; and (2) adding her name to the title. Although there may be reasons why this should not be accomplished, I would think it’s the simplest and most cost-effective way to go. Otherwise, on your father’s death, his estate (depending on your state law) may have to go through the probate court.
I seriously doubt that the lender will require your mother to move out of the house. However, the mortgage has to be paid. If probate is required, and there are no other funds available to pay it off, the house may have to be sold to satisfy the lender.
Accordingly, in addition to following the suggestions I made above, I would also talk with the lender. If your mother can continue to make the monthly mortgage payments, I see no reason why the lender would object.
Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to firstname.lastname@example.org.
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Copyright 2012 Benny L. Kass