The name of this blog is Duplex Chick.
Not Accountant Chick.
To that end, please heed the following disclaimer: if you’re a duplex home owner facing a short sale or foreclosure, please consult with an accounting chick when you’re considering your course of action.
Don’t worry. She’ll be in a good mood. She’s going to have plenty of business.
See, even though Minnesota is a non-recourse loan state, meaning the mortgage is collateralized by the property; the bank can’t come after you for the amount of the loan you’re forgiven through a short sale or that’s lost on a foreclosure.
However, if you’re an investor, the IRS may perceive that forgiveness as a “capital gain”, and therefore might pursue you for capital gains tax. Oh, and remember how you depreciated the heck out of the place on your taxes? Depreciation recapture tax still exists; even if you didn’t sell the property for a profit.
On the other hand, if you lived in the duplex, the Mortgage Debt Relief Act of 2007 allows you to exclude up to $250,000 of gain if the property was your principal residence for at least two of the last five years. Whether or not this exception applies to the half you didn’t live in is a question for that accountant.
But just like the investor, you depreciated the heck out of the side you didn’t live in too, right? After all, that’s one of the many advantages of duplex ownership.
Guess what. Depreciation recapture probably applies to you too.
Depressing, yes. But remember, insofar as the capital gains tax, it pertains only to the amount of debt you were forgiven. So if you owed $150,000 and sold the duplex house for $100,000, you’d be taxed on the $50,000 you didn’t pay.
However, if you lost the duplex to foreclosure, you’d be taxed on the entire $150,000.