Tax Issues With Walking Away From a Rental Property

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Are you looking at an upside down real estate rental that is eating you alive in payments?

There are a number of options, if you’ve got the cash flow to make it through the challenge. One of them could be just holding on until the market turns or finding a way to attract more or better tenants.

But if you’re broke, and not able to keep going, you have a limited number of options. In a nutshell, you can try to:

    (1)Get a loan modification (good luck with that. Banks seem to have shut those down cold!)
    (2) Sell with a short sale (depending on the property, banks seem reluctant to help out on these either)
    (3) Negotiate a deed-in-lieu of foreclosure (these are harder to do these days as well) or
    (4) Foreclosure.

In each of these cases, you’re going to have one of two things happen:

    (1) The bank will come after you for the extra debt owed, or
    (2) The bank will forgive part of the debt.

If the bank forgives debt, that is called “Cancellation of Debt” (COD). COD income is taxable to you.

Let’s say you have a property with a loan of $250,000 that is now worth $150,000. The difference of $100,000 could mean a huge tax bill or it could mean nothing at all!

If you have COD and:

    (1) Declare bankruptcy,
    (2) Are insolvent or
    (3) It’s associated with your principal residence, then

You have no federal tax. However, you may still have state income tax.

There is one more point to consider:

If you are disposing of a real estate rental, there is one more factor:

The disposition will cause a gain or loss.

Let’s carry on with the example before of a property that has a loan of $250,000 that is now worth $150,000. You have COD income of $100,000.

But how much of a loss or gain do you have? There are three more things you need to know:

  • What is the amount of basis you have in the property?
  • What is the amount of accumulated depreciation you have in the property?
  • How much in suspended losses do you have?

If you don’t know the answers to those questions, ask your tax preparer. You’ll need that information before you can calculate all of the tax consequences from disposing of bad real estate.

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