Current conditions of world financial crisis have led to the situation when many mortgages lose in value and sometimes debt even exceeds current value of the property. The article that I have chosen for analysis is called “Tax Consequences of Mortgage Discharge”¯. It describes the nuances of dealing with such mortgage and considers the American Recovery and Reinvestment Act of 2009, which allows to cancel indebtedness for the period between 2009 and 2014, and recognize it proportionally during 5 years after the stop of the cancellation.
The article describes several common accounting situations when mortgage debt has to be restructured, sold or cancelled, and the issues of taxation concerning this debt. Typical situations described in the article are foreclosure, bankruptcy, debt restructuring, debt buyback, American Recovery and Reinvestment Act (ARRA) deferral and spreading of COD income (Smith, Ariail and Evans, 2009). The example of LLC with two equal owners with an “upside down”¯ mortgage is discussed, and four basic situations are regarded using this example.
The paper explains how to restructure mortgages on business real estate in cases when property values are depressed and cash flow is reduced. It is shown that members of the LLC usually share consequences of restructuring, foreclosure or bankruptcy, including taxes. In case of foreclosure tax consequences are lost, but it depends on whether the debt is recourse or nonrecourse. For recourse debts, there may happen debt cancellation, but for nonrecourse debts the sale price is regarded as the balance owed to the lender. Filing a bankruptcy will lead to tax benefit at the level of an owner or an individual, although filing a bankruptcy at the entity level may stop or delay a foreclosure (Smith, Ariail and Evans, 2009). When the client needs to restructure the debt to provide more favorable terms, including a reduction in the principal balance of the debt, debt restructuring or buyback is used. In case of debt restructuring or debt buyback, the difference between the new debt and the old debt is taken into account, and this difference is recognized as cancellation of debt income, which should be included into gross income. At the same time, the new Recovery and reinvestment Act allows those who recharacterize the debt in 2009 and 2010, may choose deferring and amortization of the COD income after a free of taxation five-year period, ending in 2014.
There are many positive aspects in the structure of the article. It has a clear logic of presentation and shows how to apply the regulations of the Recovery and Reinvestment Act of 2009 in practice. The article is illustrated with mortgage discharge schemes and outlines the most important issues. However, the text of the article sometimes does not explain several issues that might be questionable concerning mortgage discharge, and the chosen example does not show all major nuances.
Taking into account the dynamically changing economical situation and its unstable perspectives, the CPAs should pay additional attention to large debts such as mortgage and prevent or quickly solve problems related to “upside down”¯ debts. Tax planning, especially in cases of various forms of bankruptcy, is a complex issue and the article “Tax Consequences of Mortgage Discharge”¯ concisely and with practical examples explains the application of new reinvestment procedures. It will be useful to all individuals dealing with taxation and mortgage questions, and to all CPAs.