Archive | May, 2012

Consumer Debt Rises $21.4 Billion in March, 2012

Are credit cards and consumer loan debt making more bankruptcies inevitable?

Continuing our break from discussing the tax effects of foreclosures, I would like to share a significant story that was reported on Tuesday, May 8, 2012 on page A9 of the Tacoma News Tribune. According to the story, Americans are back at it again—increasing their use of consumer debt. This is the biggest one month increase in a decade, since 2001.

According to the article, consumer debt rose by $21.4 billion in March from February, the seventh straight monthly increase and the largest since November 2001. Auto and student loans also increased by $16.2 billion, according to the article. A gauge of credit card debt rose $5.2 billion after declining in January and February 2012. One ray of sunshine in the report is that total “only” borrowing rose to a seasonally adjusted $2.54 trillion, which is below the all-time high of $2.58 trillion reached in July 2008.

What does this mean? Overall consumer borrowing declined by only $40,000,000,000 over 10 years. There is still an awful lot of debt still out there. I think that bankruptcies are almost certain to increase again, particularly as most markets have plenty of people discouraged about sagging or deflating housing prices.

My advice to you is that if you cannot see yourself being “debt free” of all consumer debt (car payments, credit cards, student loans, and tax debts) within 36 months, then you should consult with a qualified bankruptcy lawyer to see if a Chapter 7 or Chapter 13 bankruptcy filing might be the best option to get your financial life back on track.

Rent vs. Buy Analysis for Home Owners

A Story in the Wall Street Journal illustrates the recent decline of home ownership

I came across an interesting story about a major demographic shift among home owners and home builders in the USA recently. The article was written by Yahoo Economics Editor Daniel Gross, The story appeared in the May 5-6, 2012 edition of the Wall Street Journal.

Mr. Gross notes that single family new home starts have dropped from over 1.1 million in 2007 to just a bit over 400,000 in 2011. He also reports that home ownership has dropped from 69% in 2006 to 65.4% today. Mr. Gross points out that, according to Moody’s, in 72% of metropolitan areas, it was cheaper to rent than to own, up from 54% a decade ago. In 2011, single-family housing starts fell 9% from the year before, starts of structures with five or more units were up 60%. In the first quarter of 2012, starts of multifamily housing structures were up another 27%, while single family starts were up only 16.7%.

Mr. Gross also points out that builders increasingly intend to rent out what they build. In 2007, only 62% of the housing units in buildings with two or more units were built for rental. In 2009, 84%of the units in such buildings were built for rental. In 2011, 91% of the units in such structures were aimed at the rental market.

Many of you with whom I have met have heard me recently speak of a shift towards renting. Mr. Gross echoes some of my thoughts on this point in his story.

We all know that life is about change. For example, your job may disappear, you may need to relocate if your company pulls out of the area and offers you a relocation, you may need to travel to another part of the country to help a child raise a sick or needy grandchild, you may need to relocate to take care of the affairs of an aging relative, some parts of the country may recover economically faster than where you are currently living, potentially offering you greater opportunities somewhere else.

If you feel the need for some flexibility in your living, employment, and relocation opportunities, then you may consider renting for a while. In most areas, housing prices are not increasing. Taking a break from home ownership to rent and to put your financial house in order might not be economically harmful. Renting might be a prudent choice in some cases.

If you need to get out of your underwater house, your underwater mortgage, or you want to discuss your rent vs. buy analysis and how the decision may be affected by your bankruptcy filing, please, give us a call at 253-383-1001. We are here to help.

Analysis of Discharge of Indebtedness Income vs. taxable debt forgiveness income

Short sales and tax consequences, part 4 of 7

In this post, we will review definitions of Discharge of Indebtedness Income vs. taxable debt forgiveness income. Note that the tax consequences of foreclosure or “short sale” of a commercial or rental property will likely be much different than I will cover in this article. In this series, we are focusing on your primary residence.

You could be facing foreclosure or short sale nearly anywhere in Western Washington. Wherever you live in the state, we can help you to become aware of and informed about the potential tax consequences of a “short sale” or foreclosure.

As discussed before, the $250,000 capital gains exclusion plays a large role in whether you have taxable income on your personal residence post short sale or foreclosure.
Note that this analysis is limited to your personal residence in which you have lived for at least two years. Properties that you received as a gift or inheritance can have a different result as well, so always consult your qualified tax professional in any distress sale situation.

The National Consumer Law Center’s publication “Foreclosure Prevention Counseling”, 2009 edition, available for $60.00 at www.consumerlaw.org, covers these topics in Chapter 9, pages 147-152.

Please note that the Discharge of Indebtedness Income is not necessarily always the same as taxable debt forgiveness income.

What do we mean by “Discharge of Indebtedness Income”? The IRS considers that a taxpayer has income from discharge of indebtedness when a lender forgives some or all of a debt. If the obligation to repay a debt is forgiven, then the government looks to see if that borrowed money now constitutes income to the borrower and, if so, how much. That income is taxable like any other income the homeowner receives. Nevertheless, as described in posts five, six and seven of this blog post series, there are a number of exceptions that may mean that discharge of indebtedness may produce no taxable income at all.

Let’s review three situations in which tax might be due, but rarely result in any taxable income.

First, if there is a foreclosure and the homeowner is not liable for the deficiency, that forgiveness of the deficiency is a discharge of indebtedness income.

Second, another example is a short sale where the house sells for less than the debt and where the lender has agreed to forego any deficiency.

Third, if a loan modification is made in which the lender forgave the principal of the debt or wrote the debt down. The amount of forgiven debt would also be discharge of indebtedness income.

Note that discharge of indebtedness income is very different and distinct from capital gains income. The example that follows below is from an earlier blog post (the third of this seven part series) to help illustrate difference. Please note that it is possible for a short sale to result in both a capital gain and also a discharge of indebtedness situation. Each of (1) capital gains and (2) discharge of indebtedness must be analyzed separately and independently.
Example: A single person completing short sale-illustration of development of capital gain and discharge of indebtedness income

$50,000 original purchase price of principal residence many years ago (no funds expended on improvements during ownership so as to increase basis)
$210,000 amount on mortgage after many rounds of refinancing to “pull out equity”
-$150,000 less: short sale price when homeowner falls into financial distress
$60,000 indebtedness not paid due to short sale
$100,000 capital gain ($150,000 short sale price – $50,000 acquisition price = $100,000)
$60,000 Discharge of Indebtedness Income (but Debtor may not have to pay tax on the $60,000 amount. In later blog posts in this series, we will work through defining and differentiating Discharge of Indebtedness Income vs. taxable debt forgiveness income)
$100,000 capital gain. No taxes are due because the capital gains exclusion is $250,000 for a single person on a principal residence.

OK, so our stressed out example short sale debtor above is off the hook for capital gains tax! But will he/she escape income tax on the $60,000 discharge of indebtedness income tax? I will discuss this situation further in future posts on this topic.

Analysis of a Short Sale of a Principal Residence

Short sales and tax consequences, part 3 of 7

In this post, we will review an example of the short sale of a principal residence. In some ensuing posts, I will review the definitions of “discharge of indebtedness income” and also “taxable debt forgiveness income” to follow up on this and earlier posts that discuss foreclosures and short sales. The tax foreclosure or short sale of a commercial or rental property will likely be much different that described in this post.

The $250,000 capital gains exclusion plays a large role in whether you have taxable income on your personal residence post short sale.

Note that this analysis is limited to your personal residence in which you have lived for at least two years. As stated earlier, investment, commercial and rental properties will have a much different result than discussed here-remember to always consult your tax professional. Properties you received as a gift or inheritance can have a different result as well, so always consult your tax professional.

Discharge of Indebtedness Income is not necessarily always the same as taxable debt forgiveness income, according to the NCLC manual “Foreclosure Prevention Counseling”, 2009 edition, on page 149. The National Consumer Law Center’s publication “Foreclosure Prevention Counseling”, 2009 edition, is available for $60.00 at www.consumerlaw.org.

Example: a single person completing a short sale

$50,000: original purchase price of principal residence many years ago (no funds expended on improvements during ownership so as to increase basis)
$210,000: amount on mortgage after many rounds of refinancing to “pull out equity”
-$150,000 less: short sale price when homeowner falls into financial distress
$60,000: indebtedness not paid due to short sale
$100,000 capital gain: ($150,000 short sale price-$50,000 acquisition price = $100,000)
$60,000: Discharge of Indebtedness Income (but Debtor may not have to pay tax on the $60,000 amount. Please read later blog posts in this series as we work through defining and differentiating “Discharge of Indebtedness Income vs. taxable debt forgiveness income)
$100,000 capital gain: no tax due, because the capital gain exclusion is $250,000 for a single person on a principal residence.

Please remember that my staff and I are here to help you, regardless of whether you are facing a foreclosure or short sale, anywhere in western Washington state.