Paul L. Caron
Dean


Sunday, May 9, 2010

Faisal Shahzad's Tax Problem

Faisal Shahzad Faisal Shahzad, the attempted Times Square bomber, purchased his home at 119 Long Hill Avenue, Shelton, CT in July 2004 for $273,000 -- he put down 20% ($54,600) and took out a conventional 30-year mortgage loan from Chase for $218,400.  In February 2009, he took out a $65,000 equity line of credit from Wachovia. In September 2009, Chase filed for foreclosure in Connecticut state court, reporting an unpaid balance on the first mortgage loan of $200,000.   (For details, see CNN, New York Times, Wall Street Journal, Washington Post.)

The Weekend Wall Street Journal explains the tax consequences of folks like Shahzad with their homes in foreclosure in A Surprise Tax Hit on Foreclosures: For People Who Lose or Walk Away From Their Homes, A Big Tax Bill May Loom, by Jeff D. Opdyke:

As the U.S. economy continues struggling with the fallout of the debt-induced housing crisis, millions of homeowners ... are discovering that their decision to walk away from a mortgage could result in tax bills running into the thousands or tens of thousands of dollars.

The upshot: anyone weighing whether or not to seek a mortgage modification—or debating whether to abandon a house that is worth less than the mortgage—should consider the tax treatment carefully before making a move. The same holds for any form of consumer debt that a bank ultimately cancels, including credit-card balances or an auto lease.

Federal and state tax laws have long viewed canceled debt as income because consumers who borrow money to buy a house—or who pull money out of their house to buy cars and such—and then don't pay it back "wind up ahead of where they were," says an IRS spokesman. ...

Overall, the IRS estimates that individual taxpayers will have filed nearly 3.6 million tax returns for 2009 that include income from canceled debt. That's down a bit from 2008, but up 17% from 2007. The numbers include taxes due on primary homes, vacation and rental property, credit cards, auto leases and other canceled debts. The IRS projects the numbers to rise in coming years.

Part of that rise will likely come as the government expands its mortgage-modification program, including a call in March by the Obama administration for banks to reduce principal as a way to help people remain in their homes. That reduction could lead to tax obligations.

At first the government's mortgage-modification program focused on primary mortgages, which are tied to the purchase or construction of a primary residence, and which are eligible for exemption under a 2007 Congressional act aimed at helping homeowners avoid the tax implications of a foreclosure. That act—the 2007 Mortgage Forgiveness Debt Relief Act—exempts taxpayers from as much as $2 million in forgiven debt. But the debt had to be acquired before Jan. 1, 2009—and had to have been used solely to buy, build or remodel/repair a primary residence.

The government's new, expanded modification programs include short sales, in which a bank agrees to accept as full payment less than the value of the mortgage balance; deed-in-lieu transactions, when a homeowner gives the house to the bank instead of repaying the mortgage; and second mortgages such as home-equity lines of credit. In many of those instances, say Treasury officials, homeowners used mortgage money to fund everything from tuition and medical bills to vacations and cars and even the down payment on a second home or investment property. That debt, however, isn't eligible for exemption. ...

Some homeowners can avoid the taxes completely if they can prove insolvency, in which the total value of debt exceeds total assets. But even that could leave some owing taxes. IRS rules stipulate that a taxpayer can escape taxes up to the extent of insolvency, meaning that if one's liabilities are $500,000 and assets are $300,000, the $200,000 difference is the extent of the insolvency. But if the person has $250,000 in debt canceled, then $50,000 is taxable income.

WSJ Chart 

https://taxprof.typepad.com/taxprof_blog/2010/05/faisal-shahzad.html

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As details emerged about Faisal Shahzad, the man who allegedly tried to set off a car bomb on May 1 in Times Square, much was made of the fact that, for a while, he lived a typical American lifestyle. Sadly, that nowadays means that he encountered trou... [Read More]

Tracked on May 10, 2010 12:28:11 PM

Comments

Next thing you know, he's gonna have to answer to the Coca-Cola company.

Posted by: Patrick Carroll | May 9, 2010 12:02:50 PM

Do banks send out 1099s or other notice to the IRS for debt forgiveness, or are borrowers trusted to know this law and to report this income? If not, I bet not 10% will pay this.

Posted by: Mark | May 9, 2010 12:03:04 PM

So, like they did to Al Capone, the IRS will be the ones to end Faisal Shahzad's reign of terror?

Posted by: patch | May 9, 2010 12:08:27 PM

That is the least of his worries!

Karla

Posted by: Karla Simon | May 9, 2010 12:27:47 PM

Perhaps he has a fraud problem: are devout Muslims permitted to employ debt? did he ever intend to repay the loan?

Posted by: DINAH | May 9, 2010 1:09:07 PM

Since I'm not a terrorist, I doubt I'll get all the benefits and delicate considerations that Muslims get these days, but here are some sincere questions:

Since this income stream came from putative capital gains attached to the owner's house, would such taxpayers be eligible to pay capital gains taxes, or does income from second mortgages constitute regular income taxed at the higher rate? Also, when do the higher tax rates kick in for capital gains? I understand it's sometime this year... I may have a substantial gain on my house, and am considering selling in the next few months. Will it make any difference? Again, I am not a terrorist, and not really a part of any classic grievance class, so I'm probably screwed. (Shouldn't that fact qualify me for SOME kind of grievance group/guvmint support? )

Posted by: Morton Doodslag | May 9, 2010 1:21:07 PM

I guess the guy's in hot water now.

Posted by: Dan | May 9, 2010 1:23:10 PM

Why the full address?

Posted by: Josh Fulton | May 9, 2010 2:54:17 PM

What are they going to do, put him in jail?

Posted by: Fat Man | May 9, 2010 4:44:22 PM

When you can't trust Homeland Security to catch people, turn them over to the IRS.

Posted by: Woody | May 9, 2010 5:17:29 PM

It's much easier to escape death than to escape from Uncle Sam's greedy claws.

Posted by: ic | May 9, 2010 6:57:49 PM

SO let me get this straight...

Governments were co-conspirators in the unrealistic skyrocketing of real estate values. They then reaped the rewards in higher property tax receipts.

But now that those inflated values have dropped, if some of your mortgage is forgiven you might pay taxes on the difference? How is value that never existed in the first place considered taxable income? They get ya either way. What a scam.

Posted by: Looking Around | May 9, 2010 9:11:14 PM

Looking Around - if homeowner extracted funds from inflated, nonexistent value and the spent those funds - he got something which can be valued and owes taxes on it. Got it? He's hardly being taxed on something non-existent. Most of these players spent their cash out on boats, cars, tuition, vacations ....... Stuff. Taxable.

Posted by: DINAH | May 10, 2010 8:57:14 AM

"...homeowners used mortgage money to fund everything from tuition and medical bills to vacations and cars..."

Like a '93 Pathfinder? Guess we know how Mr. Shahzad used his equity.

Posted by: TakeFive | May 10, 2010 9:56:39 AM