A woman who had abandoned her residence must pay taxes on a capital gain after the bank sold the property after foreclosing on the mortgage, according to a new Tax Court verdict.
In the case of Drucella T. Malonzo v. Commissioner, the court rejected the woman’s contention that she had realized an ordinary loss (Drucella T. Malonzo v. Commissioner, TC Summary Opinion 2013-47, June 10, 2013).
Drucella Malonzo purchased a home in San Francisco for $333,239 in 2005 and lived in the home until sometime in 2006. She rented out the home for part of 2007 and reported the income from the rental. She claimed $12,118 in depreciation.
Later in 2007, when she couldn’t rent out the residence, she stopped making the mortgage payments and abandoned the residence. The fair market value of the residence at that time was less than the outstanding mortgage loan balance.
The lender determined that Malonzo’s note was in default, and her mortgage was foreclosed on in 2008. The house was then resold by the lender for $278,315.
A Form 1099-A, Acquisition or Abandonment of Secured Property, was sent to Malonzo showing that the outstanding balance of her mortgage obligation was $325,855. The form said the fair market value of the residence was the resale price of $278,315, and the purchase date was Jan. 22, 2008.
The IRS determined that Malonzo had a $4,734 long-term capital gain for 2008, resulting in a deficiency of $737. The IRS said the amount she realized was $325,855 – the outstanding mortgage balance, reduced by her basis (the original purchase price of $333,239 less the recaptured depreciation of $12,118). By subtracting her adjusted basis of $321,121 from $325,855, the IRS arrived at a long-term capital gain of $4,734.
Malonzo responded by submitting an amended 2008 return, reporting a $313,737 ordinary loss from the abandonment of the residence.
The IRS contended that Malonzo had a long-term capital gain resulting from the foreclosure of the mortgage loan securing the residence. After considering depreciation allowed or allowable, the IRS believed that the foreclosure resulted in a sale or exchange in which her indebtedness exceeded her adjusted basis in the residence.
Malonzo contended that she had an ordinary loss from her abandonment of the residence. She saw her intended abandonment as a situation in which she lost the value of the residence at a time when the debt obligation exceeded the value.
The court said Malonzo purchased the property, depreciated it and walked away from it when she couldn’t rent it. At that time, her mortgage obligation was more than the value of the property and also in excess of her adjusted basis in the property.
Malonzo claimed depreciation based on her basis or cost. She said the subsequent foreclosure of the mortgage loan securing the property constituted a “sale or exchange,” even though she abandoned it. Malonzo was therefore not entitled to an ordinary loss due to abandonment that is equal to the value of the property because that would ignore the fact that she held a capital asset that was subject to a mortgage.
The Tax Court sustained the IRS痴 determination that Malonzo had a $4,734 capital gain and that there was a tax deficiency of $737.