Why are you distressed and why will you be taxed?

This blog is being offered partially as a public service, hopefully some of my readers will find the information useful to them as they buckle down for what is to come, and partially as a way for me to express my ideas on the mounting troubles caused by failed policy, greed, and blind decision making by the general public.

My primary audience will  be those that are upside down in their houses, those that owe more than the house is worth, those that want to save the house from foreclosure, those that want to give the house back, and those that are in the process of giving the house back.  Though that description seems to be directed at a bunch of different people, it is not.  Its directed at homeowners who have purchased or refinanced in the last 10 years.  Let's fact it, most of you are underwater. 

There are legal tools that can help people out of this crisis.  There are also practical tools as well.  I hope that this blog will provide a good mix of practicality and if you are really bored, you can read some of my legal rants.

Why are you distressed?  Well, the technical definition of a distressed property is that property is in danger of foreclosure.  Well, this is a narrow definition that Washington State and some other jurisdictions are using to set up enforcement actions against certain vultures.  I use vultures in the sense that there are companies and individuals that are waiting for the first Notice of Default to be recorded in your county and then they swoop down to get your money before you die a financial death.  I believe that distressed property is really any property that has more debt against it than it is worth.

The reason why I think that definition is important is that there are a lot of good people that are trying to pay what they agreed to pay back in say 2006 when the housing market here in Western Washington was strong.  Whether it is from a moral conviction or just not knowing that there are other ways, the person still pays the monthly obligation.  Well, the property, even if you can afford it now, is still distressed because the proverbial straw that broke the camel's back is only an uninsured sickness away.  So the simple fact that you owe more on your house than its worth means that it is stressing you out and thus you are distressed.

So, now we have a baseline for why you are distressed, why will you be taxed?  This is one that many of us don't even consider because lets face it, you have bigger problems to worry about...now.  The person that is living in an underwater house is likely facing reduced income, increased stress, unhappy spouse, nervous children, cranky bosses, and unhappy customers.  It is easy to say, "I have enough on my plate."  The problem is that when the time comes that we part ways with our home, whether it is by the overt act of a person in control of their life or by the fact that the head in the sand, ostrich approach failed, you the homeowner will have some potentially adverse tax consequences.

I know it seems impossible, the home that you paid so much for, is now worth a lot less, so you feel like you had a loss.  The problem is that our tax code does not recognized losses on personal consumption property.  If the property was not purchased to enable you to make more money like an investment property or a commercial property, then the loss you suffer isn't recognized from a tax perspective.  There is no, "I'm sorry you lost your house" box on the 1040 you will file next year.

To add insult to injury, the money you got from the bank, that you really didn't get because it went to an escrow agent and then to the seller is considered income to you after the bank subtracts however much the bank got from the foreclosure, short sale, or deed in lieu.  Oh, did your real estate agent fail to mention that to you?  Sorry, I thought you were working with an ethical agent.  They probably didn't tell you that the short sale they are pushing also is going to cost you an excise tax due on sale of 1.28%.  I know, details, details.

What I am driving at is that distressed properties have hidden "gotcha" traps all through them.  Whether it is information that the banks are not sharing with you about the foreclosure process, or the hidden taxes that will show up afterward, doesn't really matter.  That process of being distressed leads to being taxed, mentally, physically, emotionally, spiritually, and when you get the 1099-C, financially.