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The Tax Court recently issued a Summary Opinion, Malonzo v. Commissioner of Internal Revenue, T.C. Summ. Op. 2013-47, involving an individual who was underwater on her mortgage, and who abandoned the property, subsequent to which the mortgage loan was foreclosed. She took no formal steps to transfer title or provide the lender with notice of her intention to abandon the residence, but just stopped making payments. The residence was later resold by the lender who sent her a Form 1099-A, Acquisition or Abandonment of Secured Property, reflecting as income the outstanding balance of her mortgage less the amount for which the property was resold.
The IRS determined that she had received a long-term capital gain, based upon the difference between the balance of the mortgage and her adjusted basis in the property. She, in turn, filed an amended return in which she reported an ordinary loss from the abandonment of the residence equal to roughly the difference between her adjusted basis and the depreciation recaptured from a period in which she rented the home.
The Tax Court concluded that the abandonment of this property and the subsequent foreclosure was a “sale or exchange” under the Internal Revenue Code,” so the gain or loss would be capital. As such, the Court concluded she was not entitled to an ordinary loss (and fortunately not ordinary gain either!) because the property was subject to a mortgage which was satisfied. As such, the IRS determination was sustained.
The best lesson to learn here is that before one takes the action taken by Ms. Malonzo, it is worth spending some time with a qualified tax adviser who can explain exactly what the ramifications will be.
George Connelly is recognized as one of the leading federal tax litigators in the United States. His practice focuses on IRS audit, collection and criminal matters including civil and criminal tax litigation matters, for clients ...