Tax Rules for Home Foreclosures

QUESTION: After struggling for 4 1/2 years to make my payments, I have just lost my house through foreclosure. Can I get some relief by deducting my equity as a capital loss on my 1985 tax return?--J. A.

ANSWER: If this was your personal residence, no, you’re not entitled to declare the equity as a capital loss.

It’s a different story, however, if this was a house you owned but rented out either partly or entirely.

To determine whether you would have to report a loss or a gain in that case, you would first subtract the depreciation on the house from the price you originally paid for it. The resulting sum is your basis in the house.

From that figure, subtract the amount still remaining on your mortgage--the amount you have been relieved from repaying because of the foreclosure. The result is the gain or loss you must report.

Say you bought this business property for $100,000. Because of age and use, the value had depreciated by $20,000. The so-called basis in your house is now $80,000. If you have, say, $75,000 left to pay on your mortgage, then you would be entitled to declare a loss of $5,000 and get tax relief accordingly.

If, however, your mortgage is bigger than the basis in your house, you face a double hardship. First you lose your house through foreclosure, and then you owe taxes on the gain from a house you no longer have.

Say there is $82,000 remaining on your mortgage and the basis in the house is $80,000. You would have to report a $2,000 gain and pay taxes on it. Why? Because of the foreclosure, you got out of paying back an $82,000 debt on property the tax collectors deem to be worth only $80,000. So, you “profited” to the tune of $2,000 and will be taxed accordingly.

Q: Last month, I received over $200,000 from the sale of some real estate and put the money into a certificate of deposit at a savings and loan. I was assured that it was fully insured, even though it exceeded $100,000, because the account was recorded in my name and my wife’s name as trustees for our two children. But the more I think about it, the more worried I get. Nowhere in the passbook the S&L; gave me is insurance mentioned. Is the whole thing insured?--A. J.

A: As long as the signature card you signed for the savings and loan states that you and your wife intend for that money to go to your two children should you both die, the entire amount is insured by the Federal Savings and Loan Insurance Corp.

The account is entitled to more than $100,000 insurance--the standard maximum coverage per account holder at both savings and loans and banks--because you set it up as a so-called revocable trust. And such trusts get special deposit insurance treatment.

As far as the FSLIC is concerned (the rule, by the way, is the same at banks insured by the Federal Deposit Insurance Corp.), you could put up to $400,000 in this account and still be fully insured. That’s because there are four “deposit relationships” in that account: one apiece for you in trust for each of your children and for your wife in trust for each of your children. And since the FSLIC insures each “deposit relationship” up to $100,000, your maximum protection is $400,000.

In the event that only one of you dies, the deposit insurance on this account would be cut in half.

For an account to be a true revocable trust for deposit insurance purposes, the beneficiary named must be the account holder’s spouse, child or grandchild.

If you didn’t want this money to ever go to your children but wanted the full amount in one financial institution, there is another way you could have handled it. You could have parceled out the money into three accounts, none exceeding $100,000. One account would have been in your name, a second would have been in your wife’s name and the third would have been a joint account in both of your names. Because the federal regulators consider those to be three different deposit relationships, the full amount would be insured.

Keep in mind, though, that if you or your wife already had established savings or checking accounts in that financial institution, the maximum insurance on your new accounts would be affected by that. In other words, all of the savings and checking accounts in your name at a single institution are added together for insurance purposes and the aggregate is insured for up to $100,000. The only exceptions to that are revocable trusts and irrevocable trusts (such as IRAs), which are insured separately.