- How to deal with cancellation of debt issues
- Understanding the difference between recourse and non-recourse debt
- Computation of the potential capital gain on a short sale
- Various other tax aspects of short sales
Tuesday, May 10, 2011
Tax Implications of Short Sales and Foreclosures
Mr. Lively will be presenting "Tax Implications of Short Sales and Foreclosures" on Wednesday, May 18, 2011 before a group of realtors. The focus of the presentation will be:
Sunday, May 8, 2011
New Gift Tax Rules May Not Last Long
On December 17, 2010 President Obama signed into law a new Tax Act, The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (The 2010 Tax Relief Act). This Act was a surprise to many, and the changes made to the gift tax area were the most astounding. The annual exclusion for gifts was left alone at $13,000 per person that a donor wants to give to a donee. However, the lifetime exclusion was unified with the estate tax exclusion and changed from $1 Million to $5 Million per individual. That means that a family of wealth can effectively give up to $5 million, $10 million for a married couple, without any gift tax consequences. It is unclear if their will be any recapture of this amount or clawback should the exclusion be lowered in the future. Some members of the government already indicated that it was a mistake to not address this issue in The 2010 Tax Relief Act. The President wanted to get this bill through before the end of the year, and the word on the Hill was to not even change a comma in the Act.
That is the good news. This creates a tremendous planning opportunity for families that have a donative intent toward other family members. However, this opportunity will only last for two years as the Act currently is written. Further, President Obama has already indicated that he would like to modify this portion of the Act before it is set to expire. He wants to see the exclusion back at $1 Million and the tax rate at 45 percent for gifts (it is currently 35 percent). The message from this is that you should not sit and wait on this one. If you want to take advantage of this opportunity you will need to act fast and do your planning, because this one is sure to not last long.
That is the good news. This creates a tremendous planning opportunity for families that have a donative intent toward other family members. However, this opportunity will only last for two years as the Act currently is written. Further, President Obama has already indicated that he would like to modify this portion of the Act before it is set to expire. He wants to see the exclusion back at $1 Million and the tax rate at 45 percent for gifts (it is currently 35 percent). The message from this is that you should not sit and wait on this one. If you want to take advantage of this opportunity you will need to act fast and do your planning, because this one is sure to not last long.
Monday, April 25, 2011
Recourse v. Non-Recourse Debt in California
A big question that arises in California these days is whether the debt on your real estate is recourse or non-recourse. The difference can be quite significant if you are going through a foreclosure, deed in lieu of foreclosure, or a short sale. If the debt is non-recourse and you go through a foreclosure, deed in lieu of foreclosure, or a short sale, there is no potential for a deficiency on the loan and there is no income from any cancellation of debt. However, if the debt is recourse there is a potential for a deficiency and income from cancellation of debt. Recourse debt creates personal liability for the debtor for the portion of the debt that is not repaid to the lender. That is why this determination of recourse v. non-recourse is so important as an initial hurdle.
A note can be non-recourse if the contract that creates the debt indicates that it is a non-recourse note. Purchase money notes in California are also non-recourse by definition. A purchase money note is a note whereby the borrower borrowed money to purchase a principal residence and the funds went directly into escrow and then to the seller of the property for the purchase of a one to four unit property. Thus, seconds, HELOCS and Refinanced Loans on property would typically not be a purchase money note and would create personal liability in the event of a default on the note.
California has come to the rescue with SB 931 with regard to short sales. If a lender agrees to a short sale in writing in California the First Trust Deed on a one to four unit property is non-recourse and the lender can only look to the property for repayment. Notice that this Bill does not exclude rental properties. Therefore, if a borrower has a potential issue with a deficiency on a first trust deed, whether it is a rental or a principal residence, the borrower should attempt to short sale the property to avoid a deficiency judgment of the property. SB 931 does not work for foreclosures or deeds in lieu of foreclosure. It is only for short sales.
When you are disposing of distressed real estate there are numerous tax and legal issues that you must address and be aware of prior to closing the transaction. Make sure that you consult with a tax attorney to make sure you do not have any hidden costs that you will be later surprised by when it is too late.
A note can be non-recourse if the contract that creates the debt indicates that it is a non-recourse note. Purchase money notes in California are also non-recourse by definition. A purchase money note is a note whereby the borrower borrowed money to purchase a principal residence and the funds went directly into escrow and then to the seller of the property for the purchase of a one to four unit property. Thus, seconds, HELOCS and Refinanced Loans on property would typically not be a purchase money note and would create personal liability in the event of a default on the note.
California has come to the rescue with SB 931 with regard to short sales. If a lender agrees to a short sale in writing in California the First Trust Deed on a one to four unit property is non-recourse and the lender can only look to the property for repayment. Notice that this Bill does not exclude rental properties. Therefore, if a borrower has a potential issue with a deficiency on a first trust deed, whether it is a rental or a principal residence, the borrower should attempt to short sale the property to avoid a deficiency judgment of the property. SB 931 does not work for foreclosures or deeds in lieu of foreclosure. It is only for short sales.
When you are disposing of distressed real estate there are numerous tax and legal issues that you must address and be aware of prior to closing the transaction. Make sure that you consult with a tax attorney to make sure you do not have any hidden costs that you will be later surprised by when it is too late.
Sunday, April 24, 2011
Tax Implications of Short Selling Real Property
Short Sales of Real Estate
When you sell real property in a Short Sale Transaction there are numerous tax implications that you will want to consider. First, just what is a Short Sale. A short sale is when you sell a property and the sales proceeds are not sufficient to pay off the loan that you have on the property and you ask the lender to accept less than the full amount they are due to pay off the loan.
When you short sale a property the tax considerations revolve around two basic issues. First, the income from the cancellation of the debt, and next any gain that may have to be recognized on the sale. Cancellation of debt income occurs when you pay less than the full amount back to the lender. When you borrowed the money from the lender you did not have to pay tax on the borrowed money because you were obligated to pay back the debt. However, when the debt was canceled and you did not have to pay it back that is income. The lender will send you a 1099C informing you and the IRS of the canceled debt. You will also have to determine if there is a gain on the property you disposed of in the transaction. The IRS considers this disposition a sale and you must report the sale less the tax basis in the property. This could result in a gain if you have a low basis in the property and refinanced it pulling out cash.
The next thing that you need to consider is whether the income from the Cancellation of the Debt is actually taxable. There are four exclusions that must be considered. First, if the debt is non-recourse (as determined by state law) there can be no income from the cancellation of the debt; Second, if the home was your principal residence the debt is excluded up to $2,000,000 by the Mortgage Forgiveness Debt Relief Act of 2007; Third, if you are insolvent the cancellation of debt is forgiven to the extent that you are insolvent at the time the debt is forgiven; Fourth and finally, if you are bankrupt the cancellation of debt is forgiven if it was included in your petition.
The cancellation of debt and how you handled it for tax purposes is reported on Form 982 that is included with the filing of your form 1040. This is where you also adjust the basis for assets where debt was canceled.
When you sell real property in a Short Sale Transaction there are numerous tax implications that you will want to consider. First, just what is a Short Sale. A short sale is when you sell a property and the sales proceeds are not sufficient to pay off the loan that you have on the property and you ask the lender to accept less than the full amount they are due to pay off the loan.
When you short sale a property the tax considerations revolve around two basic issues. First, the income from the cancellation of the debt, and next any gain that may have to be recognized on the sale. Cancellation of debt income occurs when you pay less than the full amount back to the lender. When you borrowed the money from the lender you did not have to pay tax on the borrowed money because you were obligated to pay back the debt. However, when the debt was canceled and you did not have to pay it back that is income. The lender will send you a 1099C informing you and the IRS of the canceled debt. You will also have to determine if there is a gain on the property you disposed of in the transaction. The IRS considers this disposition a sale and you must report the sale less the tax basis in the property. This could result in a gain if you have a low basis in the property and refinanced it pulling out cash.
The next thing that you need to consider is whether the income from the Cancellation of the Debt is actually taxable. There are four exclusions that must be considered. First, if the debt is non-recourse (as determined by state law) there can be no income from the cancellation of the debt; Second, if the home was your principal residence the debt is excluded up to $2,000,000 by the Mortgage Forgiveness Debt Relief Act of 2007; Third, if you are insolvent the cancellation of debt is forgiven to the extent that you are insolvent at the time the debt is forgiven; Fourth and finally, if you are bankrupt the cancellation of debt is forgiven if it was included in your petition.
The cancellation of debt and how you handled it for tax purposes is reported on Form 982 that is included with the filing of your form 1040. This is where you also adjust the basis for assets where debt was canceled.
Sunday, December 12, 2010
Basic Asset Protection Strategies
Today I am going to talk to you about Three Methods to Provide Asset Protection to Your Wealth. This is not a complete list, but Three easy to implement common methods that any estate can take advantage of to shore up their Asset Protection planning. But before I discuss why you need asset protection let’s first discuss what asset protection is.
According to Jay Adkisson in his book Asset Protection, asset protection is pre-litigation planning to deter lawsuits and promote settlements. The primary goal of asset protection is to bring closure to actual or potential litigation with as little disruption to the debtor’s business and with as little loss of wealth as possible. What asset protection planners do is best described as Wealth Preservation.
When should Asset Protection be done? The answer is simple – the earlier the better. It is like buying insurance. You cannot wait until after the accident to do the planning or purchase the insurance. Then it is too late. The same goes for asset protection planning. The biggest hurdle for asset protection is the Fraudulent Transfer Laws.
According to Adkisson, it is not the structure that is created for asset protection that should be given the greatest emphasis. It is the method and timing of the transfer into the structure that is most important. So what is a Fraudulent Transfer? It is a transfer in derogation of the rights of a creditor to satisfy his judgment against the assets of the debtor. What happens if the Court determines that a transaction is fraudulent? The transaction is unwound as though it never happened.
Why should we be concerned with Asset Protection? According to SixWise.Com there are over 16 million lawsuits filed in the United States each year and this number is rising by about 12 percent each year. The group Lawsuit Abuse indicates that of these 16 million lawsuits 1.4 million lawsuits are filed in California each year. That is almost 7000 lawsuits filed each day the courts are open. Therefore, the question has become not if you will be sued in your lifetime, but when. And if you are a person of wealth you have a 100 percent chance of being suit once if not multiple times in you life.
According to SixWise.com, many of these lawsuits are filed against doctors and other professionals. With the economy that we are in and the ease of filing lawsuits many lawsuits are being filed with the “I have nothing to lose mentality” with the hope of winning the lawsuit lottery.
So what can you do to protect yourself? Here are three Methods to Provide Asset Protection to Your Wealth:
1) Protecting Your Home – Your home should not be held in your name or in the name of a living trust if you have any equity that your want to protect. It is a myth that a living trust provides any type of protection. Instead the home should be transferred to an irrevocable trust such as a Qualified Personal Residence Trust or an Irrevocable Defective Grantor Trust. Both of these vehicles will add substantial asset protection. A cheap and easy protection is filing a homestead exemption on your home.
2) Protecting Your Retirement Assets – Many people believe that the assets they have in an IRA are protected from creditors. Nothing could be further from the truth. Only qualified pension plans such as 401K’s and Defined Benefit plans that have multiple common law employees in the plan are protected by ERISA – the federal law that protects pension assets. If you have a significant sum in an IRA you should consider transferring the assets to an ERISA plan for the great asset protection benefits that they offer. This may be the single best Asset Protection devise that exists. If you remember, the Goldman’s have been unable to reach O.J. Simpsons pensions assets even though they have a $38 Million judgment against him. This is how strong ERISA Protection can be.
3) Other Protections – Equity Stripping – This is an effective technique to remove equity from property by borrowing against the property. The cash is either spent or protected with asset protection vehicles such as asset protection trusts.
The bottom line is that we should all practice some form of asset protection. Most of us already do without realizing it. For instance, when we buy insurance we are practicing asset protection. The difference is whether we have a comprehensive plan to protect our assets and whether we use any of the techniques mentioned above or various other techniques that are available. The greater your wealth the more asset protection you may need, and even this will depend on your aversion to risk and the cost benefit of the plan you design. However, I think that in this litigious society we live in all of us should engage in asset protection based on the amount of wealth we possess.
Sunday, August 22, 2010
Sale of Closely Held Businesses to Defective Grantor Trusts
Owners of closely held businesses can benefit for tax purposes with the sale of the business to an intentionally defective grantor trust. This is one of the most effective techniques to freeze the value of the business owner's estate and transfer the future appreciation of the business to future generations of heirs of the taxpayer.
Due to current economic conditions and the lowest interest rates we have seen in a long time, now is the time to consider the technique of selling assets to an intentionally defective grantor trust, and take advantage of a tremendous wealth transfer opportunity. It is almost a certainty that the estate tax will come back in some form next year. If current law does not change, we will have a maximum estate tax rate of 55% and a life-time exclusion of $1,000,000. If this comes to pass, this will be the highest estate tax rate we have had in ten years.
To properly utilize this technique the deal must be structured properly. The trust document created must intentionally violate one or more of the grantor trust rules, the grantor must not retain any powers that would cause inclusion in their estate, and the document must ensure that the dispositive scheme created by the grantor is successfully created paying particular attention to extending the duration of the trust to as many future generations as possible.
The end result will be a trust that is treated as owned by the grantor for income tax purposes, but not for estate tax purposes. Thus, removing the business from the estate of the Grantor and transferring future appreciation in the business to future generations.
If you will have a taxable estate in 2011 and own a business, you should give this technique some consideration this year. It is one of many methods we can use to lower your estate tax bill with the coming return of the estate tax in 2011. Remember, the estate tax is a tax that we can completely eliminate with proper and timely planning. Leaving more of your legacy to your family.
Due to current economic conditions and the lowest interest rates we have seen in a long time, now is the time to consider the technique of selling assets to an intentionally defective grantor trust, and take advantage of a tremendous wealth transfer opportunity. It is almost a certainty that the estate tax will come back in some form next year. If current law does not change, we will have a maximum estate tax rate of 55% and a life-time exclusion of $1,000,000. If this comes to pass, this will be the highest estate tax rate we have had in ten years.
To properly utilize this technique the deal must be structured properly. The trust document created must intentionally violate one or more of the grantor trust rules, the grantor must not retain any powers that would cause inclusion in their estate, and the document must ensure that the dispositive scheme created by the grantor is successfully created paying particular attention to extending the duration of the trust to as many future generations as possible.
The end result will be a trust that is treated as owned by the grantor for income tax purposes, but not for estate tax purposes. Thus, removing the business from the estate of the Grantor and transferring future appreciation in the business to future generations.
If you will have a taxable estate in 2011 and own a business, you should give this technique some consideration this year. It is one of many methods we can use to lower your estate tax bill with the coming return of the estate tax in 2011. Remember, the estate tax is a tax that we can completely eliminate with proper and timely planning. Leaving more of your legacy to your family.
Thursday, June 17, 2010
Disabled Beneficiaries Will Benefit From A Special Needs Trust
If you are the parent of a disabled child you must consider how to leave property to your child, and whether you can provide sufficient assets to provide for your child for their lifetime. This is not as easy as it first may seem. A disabled child may never have the mental capacity to manage their own financial affairs, you may not have assets that can fund the needs of the child for the rest of their life, and if your child receives assets directly they may lose access to essential government benefits.
Fortunately, there is a solution to this dilemma that is relatively straight forward and cost effective. A Supplemental Needs Trust, or more commonly called a Special Needs Trust, can be created for the benefit of the Special Needs Child. A properly drafted Special Needs Trust will solve the above mentioned problems, and more. The trust can provide for an advocate to make sure your child receives proper care and the services that he or she needs when you are no longer there to do so. The trust can pay for your child's personal items, vacations, and social events.
There are occasions where Medicaid will not pay for certain medical care or treatments that you would have provided for if you were there to make the decision. The trustee for the trust, your child's advocate, can then step in and provide for these services if necessary. The trust is drafted such that the trustee can pay for items in their discretion so that the means test for essential government benefits is not violated.
If you do not have the wealth necessary to fund the Special Needs Trust, the trust can be funded with Life Insurance. A very cost effective strategy is to fund the trust with a second to die policy that pays out the benefit to the trust when the second parent dies. Since the policy is based on two lives, the cost is substantially less than a policy based on a single life.
A Special Needs Trust requires specific language to accomplish its goal. For example, it must state that it is intended to provide supplemental and extra care over and above what government benefits may provide. It also must state that it is not intended to be a basic support trust. It should also reference the various relevant government codes and statutes that authorize the creation of this type of trust.
It is a good idea to create a Special Needs Trust early in a child's life as a long-term means to hold assets for the child benefit, and provide for the child in the event of the untimely and early death of the parents. The trust can be created as part of the parent's estate plan. The trust can be established at any time before the child's 65th birthday.
Who should prepare your Special Needs Trust? An estate planning or tax attorney that is familiar with the special issues and provisions of this type of trust. A poorly written Special Needs Trust can cause loss of government benefits, and other financial assets. An attorney that specializes in this area knows the special concerns of this type of trust, and drafts special language into the trust document to preserve and protect the assets for the benefit of the special needs child.
Fortunately, there is a solution to this dilemma that is relatively straight forward and cost effective. A Supplemental Needs Trust, or more commonly called a Special Needs Trust, can be created for the benefit of the Special Needs Child. A properly drafted Special Needs Trust will solve the above mentioned problems, and more. The trust can provide for an advocate to make sure your child receives proper care and the services that he or she needs when you are no longer there to do so. The trust can pay for your child's personal items, vacations, and social events.
There are occasions where Medicaid will not pay for certain medical care or treatments that you would have provided for if you were there to make the decision. The trustee for the trust, your child's advocate, can then step in and provide for these services if necessary. The trust is drafted such that the trustee can pay for items in their discretion so that the means test for essential government benefits is not violated.
If you do not have the wealth necessary to fund the Special Needs Trust, the trust can be funded with Life Insurance. A very cost effective strategy is to fund the trust with a second to die policy that pays out the benefit to the trust when the second parent dies. Since the policy is based on two lives, the cost is substantially less than a policy based on a single life.
A Special Needs Trust requires specific language to accomplish its goal. For example, it must state that it is intended to provide supplemental and extra care over and above what government benefits may provide. It also must state that it is not intended to be a basic support trust. It should also reference the various relevant government codes and statutes that authorize the creation of this type of trust.
It is a good idea to create a Special Needs Trust early in a child's life as a long-term means to hold assets for the child benefit, and provide for the child in the event of the untimely and early death of the parents. The trust can be created as part of the parent's estate plan. The trust can be established at any time before the child's 65th birthday.
Who should prepare your Special Needs Trust? An estate planning or tax attorney that is familiar with the special issues and provisions of this type of trust. A poorly written Special Needs Trust can cause loss of government benefits, and other financial assets. An attorney that specializes in this area knows the special concerns of this type of trust, and drafts special language into the trust document to preserve and protect the assets for the benefit of the special needs child.
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