Underwater Minneapolis Duplex May Be Taxing

House UnderwaterA recent study by the research firm CoreLogic found the number of underwater homeowners  (those whose homes are worth less than they owe on the mortgage) now stands at 11.3 million.

That’s about one-fourth of all homeowners with mortgages.

Another 2.3 million have less than 5 percent equity in their properties.

In other words, combine the two and 29 percent of all homeowners with mortgages are underwater.

The report said nothing about duplex and small multi-family property owners.

So what does a single family homeowner, or, for that matter, a duplex owner, do if she absolutely has to sell the property anyway?

A short sale.

For a homeowner, this involves listing the property and getting the mortgage holder(s) to agree to take less than they’re owed.

For example, if the bank is owed $100,000 on the mortage, and proceeds of the sale only net $75,000, they would have to agree to forgive the difference.

Thanks to The Mortage Forgiveness Debt Relief  Act, homeowners who short sell or are foreclosed upon may not be taxed for the amount of indebtedness that was forgiven. If the mortgage was a recourse loan, the lender may come after the owner to collect the difference. If it was a non-recourse loan, which is attached only to the property used as collateral, they may not.

A duplex owner, however, may face different challenges.

If the duplex was not the seller’s principle residence, she will have to pay taxes on the short sale deficiency that was forgiven.

See, the debt relief act doesn’t cover rental or business properties, car loans, vacation homes or credit card debts.

Before you struggle to the surface for air, know that there are exceptions. The sale may not be a taxable event if one of the following is true:

  • The duplex was your principal residence.
  • Bankruptcy. Debts cancelled during bankruptcy are not considered taxable.
  • Insolvency. If your total liabilities are greater than the value of all of your assets, you are considered insolvent. In this case, the debt may or may not be cancelled.

If you are underwater on your duplex, don’t lose hope. There are solutions, and you may find through a conversation with a tax professional and qualified Realtor, that things aren’t as grim as they seem.

And even if you end up owing the IRS money, there’s always the possibility of a  Zero Equity 1031 Exchange, which I’ll talk about on Thursday.