Atlantic City Weekly

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Bad news for investors, cash-out refinancers

Benny Kass
Inman News™

DEAR BENNY: I am in the process of preparing my income taxes, and heard that I may have to pay a tax on the moneys that my lender canceled when I sold my house via a short sale. Is this correct? --Theresa

DEAR THERESA: I have to give you a good lawyer's response: "It depends." Usually under the tax laws, if your debt is canceled or forgiven, that is taxable income to you.

However, Congress thought this was absurd: You lose a house by foreclosure (or short sale), and to add insult to injury, you have to pay tax on this phantom income. Accordingly, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million -- if that debt was on your principal residence.

If the debt was on a second home or an investment property, then you are out of luck; the amount that was forgiven (or canceled) is taxable income to you.

If your canceled debt was on a refinanced loan, the law is murky. If you used the refinance proceeds to substantially improve your house, then there is no tax to pay. But if you used those proceeds for other purposes -- regardless of how significant the investment may have been -- the cancellation creates a taxable event for you.

The IRS has an excellent, free, publication on this topic, called "Canceled Debts, Foreclosures, Repossessions and Abandonments." It is Publication 4681, and will soon be published at the following link on the IRS website -- http://www.irs.gov/pub/irs-pdf/p4681.pdf -- or by calling (800) 829-3676, or (800) TAX-FORM.

DEAR BENNY: I am a senior citizen whose house is completely paid for, but would like to move to a senior community. I'm getting tired of the steps, grass-cutting, gutter-cleaning and other maintenance tasks. Do you know of any type of program that will let me move into the new house before my present house is sold? I need to sell my present home to purchase the new home. I don't want to take on another mortgage when I'm mortgage-free now.

I can put my house up for sale now, but the way the real estate market is, there is no telling how soon it will sell. I don't want to face the possibility of my house being sold before I close on the new house or the possibility that the new house is ready before my present house is sold.

That's why I'd like to move into the new house and deal with a higher monthly payment until the time when my home is sold, at which time I will refinance my new home with the proceeds from the sale. Hopefully from that sale and refinancing, I won't have a mortgage at all.

I have thought about doing a reverse mortgage, but that won't give me quite the amount that I'd like to have -- but it's a possibility. --Ronald

DEAR RONALD: To my knowledge, there is no formal program that addresses your needs. However, here are some suggestions:

First, in your case, a reverse mortgage may be an answer. If that does not generate enough money, perhaps the company (or person) who will sell you the house in the senior community will be willing to take back the difference by giving you a second trust (mortgage). In other words, they will lend you the money, which you will pay back when you sell your present house.

Another suggestion: Consider a bridge loan. This is a mortgage on your current house. It is called a "bridge" because it is used to cover the gap between the time you buy the new house and sell your present one. Most banks should be willing to make such a loan to you, especially because you now own it free and clear.

A third suggestion: Sell your house, but arrange with your buyers to allow you to stay in the house until your new house is ready for occupancy. This is known as a "post-settlement (or post-escrow) arrangement." You will get all of the sales proceeds; your buyer will own the house and will have to pay the new mortgage, real estate tax and insurance. (In technical terms, this is known as PITI -- "principal, interest, taxes and insurance").

You (or your attorney or financial adviser) can determine what the daily PITI will be for your buyer, and you can pay the buyer a monthly rent based on what they have to pay. The buyer may also want a small security deposit, which will be refunded to you when you vacate -- assuming that the house is in the same condition as when he or she bought it.

But, one more word of advice: You are correct that the real estate market is very uncertain. Don't jump into buying that new house until you are absolutely sure that you will be able to sell your current one, and will get the sales price you need. Perhaps you can sign a contract with the new house, contingent on your selling your present one. Some sellers may object, but others may be happy to have found a potential buyer and may accept this contingency.

DEAR BENNY: We bought a foreclosed house in 1995 in which the garage had been converted to an illegal family room. At closing, we had up to 60 days to have the garage brought up to code either by putting it back to a garage or making it a legal family room. We changed it back to a garage in 30 days. We got all the proper permits and a new certificate of occupancy to give to the town. We did everything right. Well, 16 years later, I am on a website for our county and find out that they have us down for the extra 550 square feet of living space that we had taken off.