Real Estate blessing

[Pacun]

I have a client who purchased a house 18 months ago. He could not continue making payments on his house and forclosure was his only option. No only he lost his down payment money, his house and whatever mortgage payments he made but next year he has to pay taxes on the debt forgiveness since his house did not cover his mortgage loan. Is that correct?

[JohnH]

Pacun: If you're trying to analyze the net result of the situation, you might want to add up the total he has paid out and then subtract from that the amount he would have paid in rent to live in the same neighborhood in a home roughly the size of the one he occupied. Depending upon the dollars involved, you may find that financially he has lost less than it first appears. He might also consider that if he made a bad decision at the outset in terms of overpaying for the house or committing to more than he can afford, the one-time financial hit to get out may be less than it would have cost him in the long term to hang on to a bad investment. (More or less like selling a losing stock. Sure you get the tax loss, but you're still out real money)

As for the debt forgiveness, it depends. Did the circumstances that caused him to fall into foreclosure include the fact that he was insolvent? If so, the debt forgiveness won't cause him a tax problem.

[jainen]

>>you may find that financially he has lost less than it first appears<<

John, I'm glad to see this unusual statement. We do our clients a disservice when our sympathies obscure the true facts.

Obviously we don't know all the facts in this case, but it is important to consider economic issues such as the source of cash flow problems that led to defaulting on his payments. There are also non-economic issues such as the reasons he chose that house 18 months ago.

These aren't always popular ways to evaluate what happened. But the same reasoning is often very attractive on the front end of the deal. Consider that he wasn't able to sell his house even though foreclosure takes several months. Is that because he paid a premium price, the housing market collapsed in his town, or he got in with very little equity? All of these reasons reflect well-known investment risks that he freely accepted, perhaps even sought out, whether for increased leverage or personal amenities.