Take a Hard Look at Situation Before Turning to Bankruptcy
Question: I bought my house four years ago for $178,000. I borrowed $150,000 and now have a second mortgage for $26,000, as well as credit card debt. With all this debt, my husband has to work a second job to pay all our bills. If I sell the house and pay off the mortgages and the credit cards, I can walk away free from debt. I would want to purchase another home, though, and starting out with virtually no down payment would be tough. As an alternative, I am considering a Chapter 13 bankruptcy filing to wipe out my debt and stay in my house. Can you help me?
Answer: Probably not. You left out too much information, such as how much your home has appreciated, how much your credit card bills are and whether you’re falling behind on the payments. But here are some questions to consider:
How did you get all this credit card and second mortgage debt in the first place? Was it a catastrophe for which you failed to plan, such as a job loss or huge medical bills? Or do you just spend more than you earn? If you file for bankruptcy protection, how would that change the situation that got you into this mess? If you don’t learn to control your spending and set aside some money for emergencies, won’t you be right back in this same place in a few years?
Are you looking at bankruptcy as a way to escape your mortgages as well as your credit card debts? If so, it won’t work. Debt that’s secured by your home generally has to be paid off, one way or another.
Do you understand that Chapter 13 does not necessarily erase your debts, but requires you to repay at least some of them? That’s different from a Chapter 7, which erases most debts but may require you to give up your property, or at least the equity in your home. A Chapter 13 filing allows you to keep your home, while paying your creditors over three years. After that, the remaining balance is usually wiped out.
If, with some effort, you could pay your credit cards back over the next three years, then bankruptcy wouldn’t be a great option for you. If, however, you already are falling behind and unable to make payments, bankruptcy could be a way for you to meet at least some of your obligations and keep your home.
You should discuss your options with a qualified bankruptcy attorney before taking any action. You also should take a hard look at your spending, and make sure that if you do file for bankruptcy protection, it’s a one-time event, not the pattern of a lifetime.
Selling Second Home Can Mean Tax Bite
Q: I recently sold a vacation home that we owned for 12 years. I know that there is a tax exclusion available when you sell your primary residence, but am not sure about the tax consequences of selling a second home. Although we made little or no profit on this house, I would like to know the consequences for any gain we might have.
A: When you sell your primary residence, each owner can avoid paying capital gains taxes on as much as $250,000 of profit. So a married couple could have $500,000 of profit on a home without paying any taxes.
You’re correct that there is no such exclusion for a second or vacation home. Such property is treated like any other asset, with the profit taxed at capital gains rates. Although federal capital gains rates are lower than federal income tax rates, this tax bite can still hurt.
But only if you make a profit.
If you made some improvements to the property over the years (and kept the receipts), you can add those costs to whatever you paid for the home. That’s the figure you’ll subtract from your sale price to determine your profit. If, as you suspect, your profit wasn’t much, your tax bill won’t be either.
All this assumes you didn’t rent out your vacation home. If you did, you could run into some other tax rules regarding any depreciation you took along the way. If that’s the case, consult a tax professional for details.
Seek Expert’s Help to Catch Up With IRS
Q: In 1972, a friend quit filing with the IRS as a protest against the Vietnam War (or so he says). Now, he is thinking he might want to come back into the fold, being nearly of retirement age. He has worked quietly in the trades for very little money all those years and doesn’t even have a checking account. I told him to just start filing and take it from there. He thinks they will “come and get him.” What do you think?
A: Your friend would be smart to hire a tax pro who’s experienced in “tax controversy” -- that’s code for “smoothing things out with the IRS.” Since your friend hasn’t filed a return in 30 years, the statute of limitations hasn’t even started (it’s only after you file a return that the clock starts ticking). If he was paid cash all those years, and never had money withheld, he could owe back taxes -- it depends on how little “very little money” actually was.
On the other hand, if he did have money withheld, he’s forfeited most of it, because you generally can’t claim a refund that’s more than three years old.
What would be even sadder is if he never contributed to Social Security during his working years. If you’re low-income, Social Security checks can equal 40% or more of what you earned during your working years. But you have to pay into the system to get anything out.
You may be right that he doesn’t have much to worry about, but better safe than sorry.
Given the Internal Revenue Service’s notorious bureaucracy, it can pay to have a guide who’s familiar with how things work and who knows whom to call inside the vast IRS machine to make sure your friend’s “return to the fold” doesn’t somehow go awry.
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Liz Pulliam Weston is a contributor to The Times and a graduate of the personal financial planning certificate program at UC Irvine. She is also a columnist for MSN.com. Questions can be sent to her at asklizweston@hotmail.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at www.latimes.com/moneytalk.
