Insolvency

[MJamesB80]

When proving insolvency (total liabilities exceed the fair market value of assets)does this apply to rental property?
Example:
I owe $57,000 for a rental property. Very little equity, if any. So, if I let it go into foreclosure and I am only worth about $20,000 total, then I am insolvent, correct?
Assuming that the bank foregives me of the debt of the rental property (under the LLC) would I owe any taxes or would the cancelation of debt act come in to play and I would owe nothing?

According to About.com:Taxes, under the section "Other Exclusions for Canceled Debts" states:
"The insolvency exclusion is particularly relevant, as it will likely apply to borrowers with home equity loans or mortgages on second homes and rental properties."

Sounds like it would include rental property in the case of proving insolvency.

[HHM]

If the rental house is contained within an LLC, it probably does not matter.

But let's back up, for what purpose are you trying to prove insolvency? I assume you want to let the rental property go to foreclosure, correct? And that if the bank forgives the debt, you do not want to pay income tax on the amount of forgiven debt.

Questions:
How does your LLC file taxes, 1120-S, 1095, or 1040 w/ Schedule C?
In whose name is the mortgage?

You will want to review IRS Publication 908. If you show a positive net worth, you are not insolvent for the purposes of not paying income tax on forgiven debt. Your liabilities must be MORE than the fair market value of ALL your assets.

[Bandit]

It is not so much what you own against what you owe, it is also about not being able to meet your debt obligation and and what point that really happened.

People borrow money all the time on isufficent assets, but if they can pay it within a reasonable amount of time then they are not insolvent, for example a 30 year mortgage is more debt than they own, but it is expected to be paid within 30 years, give or take a few years....


People argue over some of these definitions like a religion, but that is really how it goes. Your definition from About.com does make sense because not everyone can pay back a second mortgage & if they lose more than a couple of months income from their renters & rental property, they can become insolvent real quick. So yes it includes rental property, in fact I know someone where that was one of the main reasons for insolvency & he did end up bankrupt- because he kept getting renters who would/could not pay their rent & it put them under in just a couple of years and it did foreclose- BUT! at the time of purchasing the buildings for rentals he was not insolvent.

Some people view insolvent and bankrupt as the same thing but it is not always the same. Say you foreclose or say someone volunteers to volunteer return a new car that they can't pay, will they get sued? could there be any judicial foreclosure? Would there be any huge delinquencies to pay? if so then they might be bankrupt.

It is kind of complicated to grasp when you start to look at all the possibilities whilst knowing all the possibilities helps people make the best decisions along the way.

I dont know about your tax question.

[Bandit]

You will want to review IRS Publication 908. If you show a positive net worth, you are not insolvent. Your liabilities must MORE than the fair market value of ALL your assets.

and that too

[MJamesB80]

Hhm

If the rental house is contained within an LLC, it probably does not matter.

But let's back up, for what purpose are you trying to prove insolvency? I assume you want to let the rental property go to foreclosure, correct? And that if the bank forgives the debt, you do not want to pay income tax on the amount of forgiven debt.

Questions:
How does your LLC file taxes, 1120-S, 1095, or 1040 w/ Schedule C?
In whose name is the mortgage?

You will want to review IRS Publication 908. If you show a positive net worth, you are not insolvent for the purposes of not paying income tax on forgiven debt. Your liabilities must be MORE than the fair market value of ALL your assets.

I filed taxes with 1040 w/ Schedule C.
As far as whose name is on the mortgage. My LLC SHOULD be on there but I must have signed something at the attorney's office at closing with my own personal name so the mortage company shows that the property is my primary residence. However, going back on my taxes from 2007 I listed that address as rental property so I officially could not use it as my "primary residence" on 2008 taxes because the definition of primary residence is a residence that you lived in 2 of the previous 5 years that you owned it. I feel like I'd be taking a chance if I let it foreclose and they sent the 1099-c and I filed taxes using that rental property address as my "primary residence."

IRS Publication 908
I read this form and it states the exclusion that will allow not having to pay taxes on the cancelled debt. They are:
Bankruptcy, Farm, Insolvency, Real Property Business Indebtedness
Insolvency: liabilities exceed your assets
I owe $57,000 for rental property
Monthly payment $541
Income from rent $725 (when they are paying and rented out)
Profit $184 (this is before taxes and insurance though)

This leaves me with little to no money for repairs or rehab after they trash the place. So lets just say that one moves out. I foreclose. Bank sells the properties at an auction for pennies on the dollar (Maybe $15,000 for both). I now would have owed $42,000. Adding up my total assets:
Car $5,000
I rent a house, so that's it. I am worth $5,000 in assets but I owe now $42,000. Therefore I am insolvent, correct?

[HHM]

Regarding selling for pennies on the dollar, many states require that the minimum bid be 75% of the mortgage balance, and if the bank takes the property in as a REO, that will be the amount. (you will need to check your state).

However, you do not calculate the amount of the forgiven debt as a liability. (it is forgiven).

So, assuming, after the house is foreclosed, all you have is a car worth $5,000 and household goods worth $1,000 and NO other debt, you would NOT be insolvent.

However, if you had those $6,000 in assets, but had $10,000 in credit card debt, you would be insolvent to the tune of -$4,000. Based on the Publication 908, that would allow you to deduct -$4,000 from the amount of the forgiven debt.
Thus, $57,000 - 75% = $14,250
Forgiven Debt = $14,250
If you were insolvent by $4,000, you must still claim $10,250 as income ($14,250 - $4,000).

[MJamesB80]

Hhm

Thanks for the clarification.
So according to the Federal Tax Rat Schedule:

http://www.irs.gov/formspubs/article/0,,id=164272,00.html

Looks like I wouldn't owe a terribly large amount if all the numbers are somewhat accurate in this case.

If I'm going to take a hit as far as credit score, would you suggest allowing foreclosure or go for chap 7 bankruptcy? I would rather just take the cheapest way out.

[HHM]

Unless you have other, substantial unsecured debt, BK is probably not the route to take.

For example, if you had $50,000 in credit card debt, and were facing this deficiency, BK would probably be a good option. But if the only financial issue you have is this potential deficiency, then I would let the home go to foreclosure and see what happens.

[MJamesB80]

Primary residence

I spoke with a lawyer briefly about the subject and he suggested to claim the property as a primary residence because that is the way it shows up to the mortgage company. (of course this was off the record)
Would you suggest doing this? If I were to get audited (chances being slim), would they consider this fraud?

[Hillbilly]

I recently went through a similar foreclosure, had rental property that stopped producing any income, and so I stopped paying on it in 2006, allowing foreclosure to proceed.
Owed about $65k on it and had negligible equity.
Prior to that time I had very good credit scores and so was easily able to purchase my present residence.
But due to "under-performing" rental properties, my expenses at that time were exceeding my income by several thousand dollars monthly, a situation that could not long sustain.
So I made a "business decision", albeit a forced one.
I arranged the sale of the one rental property that I had some substantial equity in (but losing about $15k on the sale) this allowed me to raise the needed cash to cover the expenses of moving to another state.
At that point I stopped making all payments on the remaining (non-performing) rental, AND my former primary residence ($180k first, & a $25k second) but I kept up with all other payments that were not directly associated with those two properties. (car payments, a couple of small credit cards etc.)
Both of these foreclosures were finalized and the net loss reflected was as an additional $58k in income on my 2007 taxes. However, my tax accountant filed the required forms and proofs of the insolvency that existed at the time that the foreclosures took place, and the tax liability for this this income was totally forgiven (in fact I even recieved a $2800 tax refund)
I did sweat somewhat whether I would "get in trouble" (fraud charges) for selling, and thus salvaging some equity on the one rental, but as I was able to avoid filing bankruptcy, there has been no BK "investigation" of my assets or business decisions, and thus no opening for creditor objections.

Now on the downside after three years, the only debt that is still being pursued is that $25k second mortgage on my former primary residence (used to put in a kitchen there)
Their most recent written offer was to settle for 8k.
I must mention here that I'm retired and living on pension, which creditors cannot touch, If I were employed, there no doubt at all that they would collect the entire amount plus expenses through a garnishment of my wages.

We still have several active credit cards, and active accounts at three different banks, (although we are careful to keep only minimal balances in our accounts to guard against any creditor attempts to seize the funds)
"Shopping around" we have found that we can still get credit for a car, or could even refinance our present mortgage (not a very good interest rate however)

All in all, no regrets here, we made what we thought were the best decisions at the time, sure we have "downsized", but in doing so we have simplified, economised, and now enjoy a much less stressful lifestyle. Or to put it this way, I wouldn't want back any of what I lost even if I could have it back for free.

As to your previous post, I recommend telling the truth, however with the caveat of not telling, stating, or admitting to anything, unless it becomes absolutely necessary.

My rentals were also incorrectly listed on the mortgage papers as being my "primary residence" (a common (unspoken) lender ploy to facilitate the making a loan that otherwise would be rejected- They "fill in the blanks", you, if you want the loan to go through, do not question this, but put your name on the bottom line.
ON "the record" of Mortgage, you by your signature, are accepting responsibility for every statement)
Any information that you provide can and may be used against you.
This being so, it is best to operate under the principal of "Never complain, never explain"
Make them make their case against you (which quite often turns out that they will not)
And only when or if an actual suit is brought do you need to present any defense.
In this case, it appears to me at least, that the expenses incurred in pursuing such a fraud charge would not be worth the effort.
It is a gamble, and is much dependent upon what your situation is perceived to be by the creditors attorneys. If it appears by all information that you were insolvent, and that your situation was without other recourse, then there would little likelihood of them wasting much time on such "small potatoes".
If however they have any reason to suspect that you may have substantial "unsheltered assets" that are worth going after, and promise recovery, then you had best get a good attorney of your own that knows the ropes, and knows how to negotiate.

Not to be taken as "Legal Advice" but as food for thought.

[MJamesB80]

thanks!