Your Taxes : Winners and Losers Face Real Estate Woes
For investors in residential real estate, 1993 was a year of either good news or bad news.
Millions of lucky homeowners were able to refinance their mortgages at historically low interest rates, often cutting mortgage payments by thousands of dollars a year.
Meanwhile, thousands of financially troubled borrowers walked away from homes that had declined in value. And scores more restructured loans or sold homes at steep losses, with the help of lenders that agreed to take less money than was owed.
Now that Americans are preparing to file tax returns, all of these homeowners are likely to find themselves with tax woes on a grand scale.
If you lost a lot of money but still owe tax, you should probably consult a skilled tax adviser to consider strategies for your situation.
If you refinanced, you probably owe some federal income tax. If you suffered a foreclosure, you could owe a lot. Here’s a question-and-answer guide.
Q Why would I owe more federal income tax after I refinanced?
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A Because you probably reduced your mortgage interest payments by a substantial sum. And few of the upfront costs, such as loan fees and “points,” are tax-deductible.
Consider Joe Homeowner, who traded in his $200,000 loan at 9% for a mortgage at a 7% fixed rate. He saves $3,337 annually in interest, which means he has $3,337 more in taxable income.
Assuming he’s in the 31% tax bracket, that means he’ll pay $1,034 more in tax for 1993 than he did the year before.
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Q What about the points and loan fees? I thought those were deductible.
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A Loan fees on a refinance are not tax-deductible, nor do they reduce the tax basis (that’s the cost for tax purposes) in your home.
Points, which are prepaid interest charges calculated as a percentage of your loan amount, are deductible. But they must be deducted over the life of the loan. In other words, if you got a 30-year mortgage and paid $3,000 in points, you could deduct $8.33 a month. That’s $3,000 divided by 360 months. If you secured the loan in February, that means you’d get a 1993 deduction amounting to $91.63.
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Q I’ve refinanced three times in the past two years just because interest rates kept dropping. Now I’m completely confused about what to do about the points. Do I have to continue amortizing them over 30 years, or can I now write off the points on the first two refinances?
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A You can write off the remaining points on the first two refinances, because once you refinanced again you ended the “life” of the previous loan. To illustrate, consider Sally Rateshopper, who paid $3,000 in points when refinancing her 30-year mortgage in January, 1992; $2,000 when she refinanced again in January, 1993, and another $2,000 on her final refinance in October. She deducted $100 of the points from the 1992 refinance on her 1992 tax return.
How much can she deduct in 1993? $4,917.
That’s $2,900 in points remaining from the 1992 refinance; $2,000 from the early 1993 refinance, and 3/360ths of the $2,000 from the October, 1993, refinance ($16.67). (You’re allowed to round off numbers to the nearest dollar on your tax return.)
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Q The bank took my home in foreclosure last year, which was the worst experience of my life. How could that possibly land me a tax bill?
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A If it was your first home, it wouldn’t. However, if you had a gain in a previous residence that was “rolled” into this home, you may have triggered a big tax bill. That’s because the IRS treats foreclosures as if they were home sales. The buyer is the lender; the price is considered to be the loan amount.
To show how that works out, consider someone who paid $400,000 for a home in 1989 and has a $300,000 mortgage. He bought this house with the $150,000 profit he got from his previous house that he sold at the peak of the market. As far as tax authorities are concerned, the old $150,000 profit reduced this man’s “tax basis” (cost) in his home to $250,000 ($400,000 minus $150,000).
The foreclosure triggered a “sale” at $300,000, which for tax purposes means he had a $50,000 taxable gain. Unless he buys another expensive house within the next two years, he’ll have to pay roughly $14,000 in tax, assuming a 28% rate.
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Q What happens if my lender just agreed to take less than what was owed? The house was worth less than I paid, and I couldn’t make payments on the higher loan amount.
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A You may have something called “cancellation of indebtedness income.” If, for instance, you had a $200,000 loan and the lender reduced your loan amount to $150,000, you have a $50,000 canceled debt, which is taxable income as far as the IRS is concerned.
About This Report
Today’s “Your Taxes” report, Pages D6 through D11, is a guide to preparing 1993 income tax returns. All stories were written by Kathy M. Kristof, The Times’ personal finance columnist.
