Rental Going Back to the Bank

I talk to a lot of folks that have lost a rental to a foreclosure. They bought it at the peak, they have had trouble keeping it rented, they can no longer afford the negative cash flow, etc. So the bank takes it, hopefully the bank does not pursue them for the deficiency, and life goes on. We all make bad investments from time to time.

But these same folks freak out when thy receive a 1099 from from the bank that held the mortgage for the unpaid deficiency. They check with their friends etc. and oh my gosh it’s INCOME! And the anxiety they felt when they lost the property all comes rushing back. Not to worry. Bob and his magic wand is here. Bob will waive it and poof, the income disappears.

Forgive me for being flippant, but unless the rental goes back to the days where the taxpayer was able to refinance and take out equity, the taxpayer probably has enough cost basis in the property to create a big loss that offsets most if not all of debt relief income especially if they put in a fair amount of cash into the deal.

Example. James buys a rental house for $100,000 putting $20,000 down and an interest only mortgage of $80,000. James’ tax basis is $100,000. He owns it for 3 years. During that time he depreciates the property (a paper-only tax write-off) $9,000. James loses the house at a time when the house is valued at $60,000. Since the bank was owed $80,000, they send a 1099 for $20,000. Yes indeed, that is $20,000 of income.

But James also has a tax loss. His tax basis is $91,000, the original $100,000 less the $9,000 in depreciation he took. In a foreclosure like this, James is deemed to have sold the property for its $60,000 value, for a loss of $31,000 ($60,000 – $91,000). Because it is a rental, and the rental is now totally gone, James can write off the whole $31,000 against the $20,000 debt relief income and any other income he has. If James had a suspended loss he could not deduct in prior years (that happens to higher income taxpayers) he can write that off too.  James’ net loss is $11,000, which makes sense if you think about it. He put in $20,000 and got $9,000 in tax write-offs.

This works for single family rentals, apartment buildings, shopping centers, etc. but not your residence. Residences come under completely different rules. So if you get one of these 1099s and you want to freak out, think about the possible loss you have, or contact me, and I will get out my magic wand.

New Tax Reporting Rules for Landlords

The recently enacted Small Business Jobs Act of 2010,may affect you if you are an owner-manager of rental property.  Under this legislation, you will be required to send a Form 1099-MISC annually to every vendor (individual, partnership or corporate) who provides $600.00 or more in services for your rental properties.  Think gardener, handyman, etc.  Please note that these requirements are different than and are in addition to the Form 1099 requirements that resulted from the recent healthcare legislation.

 

Starting in 2011 you need to obtain a completed IRS Form W-9 from every service provider you already use. That form will give you their correct name, federal ID# or Social Security number, and address.  And I suggest getting that information right away with any new vendors before they start work.  Do not wait and create a mad scramble to obtain the information right before the deadline.  This is the surest way to end up with incomplete forms.  

 

Beginning in 2012, annually you will be required to prepare a Form 1099-MISC and send one copy by January 31st to each vendor and by February 28, 2012 one copy to the IRS with an appropriate Form 1096 cover sheet.  Presently we do not know if California will require it’s own filings.

 

Prior to 2011 the requirement for filing only applied to businesses (i.e., rental property management companies) and not rental property owners.  If you already are making filings, then no new action is required. 

 

The IRS may assess a penalty for each 1099 with inaccurate or missing information in the amount of $100.00, although the penalty is reduced for quick corrections (before August 1 of the year sent).  That penalty applies even if the bad information is not your fault,so it is important to require all vendors to fully complete a Form W-9 so you can prove you are not responsible for the error.  If there is intentional noncompliance, like not filing a 1099 for a vendor, then the penalty is $250.00 per non-filed 1099.

Schedule E filers may want to obtain an Federal Employer Identification Number (FEIN) for reporting their rental property payments in order to avoid disclosure of their personal social security numbers to vendors.  To be clear about this, the Form 1099-MISC requires all payers to provide an identification number.  In the absence of a FEIN, the only other option will be to disclose to vendors the owner’s social security number on the Form 1099-MISC.  Note – The use of a FEIN will not change your income tax reporting in any way.

Again, because these provisions already apply to businesses, if you are already filing, legislation will not change how you file the Form 1099-MISC.  Obtaining a Form W-9 from all vendors need not wait until next year.  Both the Form W-9 and instructions are available on www.irs.gov.