Foreclosure mess

TP and spouse had a home for 30 years. Took a reverse mortgage out many years ago. I know the reverse mortgage is non-recourse. So original mortgage was about $150k and reverse mortgage was about $300k.

House has been going through foreclosure for past 5 years (one of the spouses right before the foreclosure started). TP is paying the $150k, and the $300k non-recourse debt won't be paid back.

I know with non-recourse debt that the $300k will be considered proceeds as if the house were sold. And in normal circumstances the $250k exemption could be used. But in this case, the spouse (for the past 30 years) was mistakenly not on either the original deed of the house nor the reverse mortgage. No title, no anything - only the deceased spouse. We are a community property state. Does she have to be on the title to be considered an owner? All of this is going through probate right now.

Thanks.

[ . . . ] in this case, the spouse (for the past 30 years) was mistakenly not on either the original deed of the house nor the reverse mortgage. No title, no anything - only the deceased spouse. We are a community property state. Does she have to be on the title to be considered an owner? [ . . . ]

I assume the client is in California. I don't know about California community property law, but under Texas community property law (at least, when I was in law school 400 years ago), if the property was acquired during the marriage, the property is presumptively owned as community property, regardless how the ownership is shown on the deed. The presumption can be overcome by evidence that separate funds were used to acquire the property, etc.

By contrast: If the surviving spouse acquired the property PRIOR to the marriage, under Texas law (as I remember it) the property would be the separate property of the surviving spouse -- from day one. In Texas, it's called the Inception of Title Rule. Payments on the debt do not change the state of title from separate to community in Texas. Again, this is my memory from law school; I don't practice in this area.

I don't know what California law is on this point.

Because the reverse mortgage debt was nonrecourse, the deceased spouse (whose name did not appear on the promissory note and the deed of trust) and the surviving spouse would both have an "in rem only" liability. It would indeed appear that the amount of unpaid principal would be considered part of the amount realized by the two spouses (or, rather, by the surviving spouse and the probate estate of the deceased spouse) at the time of a foreclosure sale.

Thank you. I should check with an attorney related to community property issues here.

And reading through my post, I didn't make it clear. The deceased spouse (husband) is on the title and mortgage. The surviving spouse is the one who is not on any title or mortgage and the one dealing with all of this mess.

Does she have to be on the title to be considered an owner?

Aren’t you asking the same question as whether acquiring equitable ownership or the “burdens and benefits of ownership” satisfies the ownership test for the sec. 121 exclusion? If so, our previous discussions of this issue may be helpful:

viewtopic.php?f=8&t=13112&p=
viewtopic.php?f=8&t=11357&p=
viewtopic.php?f=8&t=4110&p=

Actually - I am not asking the same thing because I have a new piece of important information.

The home was NOT foreclosed at the end. There was a "negotiation" with the bank. It's a long story (which is why I got it wrong in the first place). I guess there are some HUD specifications on what is supposed to be paid back to the bank and it's taken a few years to get to litigation.

So the original loan is getting paid back, and the non-recourse reverse mortgage is getting forgiven. And TP gets to keep the house. At first I though we can get the $250k exclusion after having the forgiveness = to sales price, but that is not happening. And I can't find that a non-recourse loan that is forgiven AND you get to keep the property. It's so unusual because of these HUD rules that I have never dealt with before. And I am getting some of this info second hand as well.

So now my question is - any exception? It's non-recourse, but property stays in the hand of the taxpayer.....

I don't think it was clear from your previous posts that there was no foreclosure and that the client got to keep the home. You can only use the $250K exclusion if there's a gain on the disposition of the residence, such as a sale or foreclosure. It can't be used to exclude canceled debt income. Since the reverse mortgage is being forgiven, and your client is keeping the home, this results in canceled debt income, not gain. See Rev. Rul. 82-202. It doesn't matter whether the loan is recourse or nonrecourse.

Thank you - it wasn't clear because I had the wrong information so I am sorry about that. Once I understood that the house remained with the TP, then everything changed. Yes - no sale exclusion at all. I will take a look at the Rev Rul.

Thank you.

I am getting updated information from the attorney. It seems to be ever-evolving, so forgive me.

This is a HUD issue. The bank started the foreclosure process on the property several years ago. That process has been in the courts, and has now been reversed 6 years later because of the payments. The TP will own the property free and clear. The bank is planning to issue a 1099 (or at least asked for the information to potentially issue the 1099).

The issue ( I think) is this non-recourse reverse mortgage. The spouse was incorrectly never on the title or the loan. Under HUD agreements, the TP's can buy the home by paying the lower of 90% of the appraised value, or the loan balance, whichever is lower. If the loan balance is lower, then HUD pays off the bank.

If she properly were on the loan (as a co-owner spouse), she would own 100% of the house upon her husband’s death and the total loan balance would be due when she died under the terms of the reverse mortgage. If she died today, her kids could buy the house for a portion of the appraised value (which is lower than the loan amount). The loan balance would be eaten by the bank. Actually, what really happens is HUD reimburses the banks for the unpaid loan balance.

If she properly weren’t on the loan (didn’t have a community property interest –eg a kid as opposed to a wife), she would have been able to buy the house as a third party back in 2013 for the low loan amount when the borrower died, and not be responsible for the loan balance overage. HUD would have paid the unpaid loan balance. She would not have to deal with any tax consequences of the cancellation of a debt because the debt was never hers. She wasn’t on the loan. The gain between 2013 and now would be all hers, and there would be a step up of basis on her death. Or if she were to sell it, she would get to use the $250k exclusion.

But because she wasn't on the loan, then she pays money into an escrow, the bank pays money into an escrow, and then all the money goes back to the bank (so the bank is paying itself back). Since the bank is issuing a 1099, then it gives us pause to understand the consequences. We don't think it should be taxable, and banks issue incorrect 1099's all the time.

Hopefully this is the final fact pattern. Thank you. This is soooo confusing.

From your post, it’s difficult to understand exactly what is fact and what “will” happen at some time in the future. It appears that this situation is still forgiveness of the reverse mortgage, resulting in canceled debt income.

Here’s how I interpret the information you’ve provided. H bought the home in his sole name with a $150K mortgage loan, and sometime later obtained a $300K reverse mortgage. H and W lived in house for 30 years. H died. Although H bought the home in his name only and was solely liable for the mortgage loans, W became involved when H died, probably because she inherited the home, subject to the mortgage loans. When she inherited the home, she became liable for the mortgage loans.

A foreclosure proceeding started 6 years ago, not sure whether this was before or after H died. W contested the foreclosure in court, and it was never completed. The parties reached a settlement in which W agreed to pay off the $150K mortgage, lender agreed to forgive the $300K reverse mortgage, and W got to keep the home.

I don’t understand how your discussion of HUD agreements affects this. But I recognize the possibility that the home was lost to foreclosure, that W never inherited the home, never became liable for the mortgage loans, and W bought the home in exchange for paying off the $150K mortgage loan. If this is the case, then there was a foreclosure that needs to be reported by H's estate.

But if my interpretation is correct, then it looks like the lender will be issuing a Form 1099-C to show forgiveness of the reverse mortgage, and since W took the property subject to this mortgage, she will have to deal with its forgiveness on her tax return.

If someone else has a different interpretation, please weigh in.

Thanks Dave. I am trying to help an attorney friend and getting mixed info, which is why this is confusing as I am getting the facts second hand. The "real" facts start at my post #8.

Yes - your interpretation is correct. And the foreclosure proceedings starting after H died. But it is now reversed after years in court.

The problem is that if the W were on the original loan in the first place, then she would own 100% of the house upon his death, and the total balance would be due when she dies under the terms of the reverse mortgage, so it seems unfair (tax is never fair or logical) that she would have COD income on this non-recourse loan. HUD agreements state she doesn't have to pay the entire balance. But I guess that's just non paying the balance isn't the same as taking that into income. And the bank is pretty clear she will be getting a 1099. What we do with that 1099 is the question. Is there ANY way to get out of this? This all relates to her not being on the community property title, deed, or loan in the first place.