DEAR BOB: Due to my husband’s job location change, we had to sell our house in Michigan where the home-sale market is very slow. His employer offered no relocation benefits, but at least my husband has a job. After listing our home on the market for six months with no purchase offers, we were unable to keep up the mortgage payments and defaulted. The realty agent suggested a “short sale” for less than the mortgage balance. Rather than foreclose, the mortgage lender agreed to accept a purchase offer for about $16,000 less than the mortgage balance. We were happy to get rid of the house and its mortgage. But then we received an IRS 1099 form showing $16,000 taxable income to us. Is this a mistake? –Helga H.
DEAR HELGA: Unfortunately for you, it’s no mistake. When a mortgage lender agrees to a “short sale” for less than the mortgage balance, the IRS considers the amount received by the lender, which was less than the amount owed, to be taxable “debt relief” income to you as the borrower.
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The IRS reasons that because you won’t have to repay that $16,000 loss the lender incurred, it is the same as if you received $16,000 income, such as job salary. While we may not agree with the IRS’s viewpoint, debt relief in the form of a mortgage short sale is taxable to borrowers. For more details, please consult your tax adviser.
IS HOMEOWNER LIABLE IF SELLER DIDN’T GET A BUILDING PERMIT?
DEAR BOB: I heard that if a previous homeowner did work that required a building permit but none was obtained, the current owner can be held liable if the work was faulty and not up to code. Please elaborate on this. –Ginger T.
DEAR GINGER: Your information is correct. For this reason, always disclose if any work was done without a required building permit.
If the nonpermitted work is minor, such as installing a new water heater without a permit, probably nobody will bother you or a subsequent owner.
However, if the work completed without a permit is significant, such as adding a family room or a major renovation, the local building department could learn of the work when you or a future owner later do work that requires a permit.
Many cities have provisions for inspecting work done without a permit without having to rip out the Sheetrock for the building inspector. Without giving your name or address, I suggest you pay a visit to the building permit department at city hall to learn the exact local procedure for remediation of nonpermitted improvements.
MUST CAPITAL GAINS TAX BE PAID IMMEDIATELY?
DEAR BOB: We are in the process of selling our homestead property to a commercial developer for a considerable amount more than the cost basis of the property. Does the IRS require capital gain tax be paid on the gain immediately upon sale? Will there be a penalty if we don’t pay immediately? –Harrison Y.
DEAR HARRISION: You must pay capital gains tax when you file your federal and state income tax returns for the year of the property sale. However, if the property was your principal residence at least 24 of the 60 months before its sale, then you can claim up to $250,000 tax-free capital gains on your federal tax returns, thanks to Internal Revenue Code 121. Up to $500,000 tax-free profits are available if both spouses meet the occupancy test.
Most states that have an income tax either conform to the federal principal-residence-sale exemption or have some form of principal-residence-sale tax break. Please check with your tax adviser, especially if you are subject to quarterly estimated income tax filing rules.
The new Robert Bruss special report, “Pros and Cons of Investing in Rental Houses and Condominiums,” is now available for $5 from Robert Bruss, 251 Park Road, Burlingame, Calif., 94010, or by credit card at 1-800-736-1736 or instant Internet delivery at www.BobBruss.com. Questions for this column are welcome at either address.
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