Wilma inherited a house from her uncle Bob, who passed away recently. Bob had taken out a reverse mortgage on his home, which means that he was paid money each month until his death and that this amount, plus accrued interest, accumulated to increase the balance of the mortgage. On Bob’s death, the balance becomes due in full, immediately, though the bank will wait up to one year to foreclose on the property, if not paid. The mortgage cannot be enforced against any assets of Bob’s estate, except the house, and none of his beneficiaries can be held liable otherwise for the debt.
The balance of the mortgage at the time of Bob’s death was $210,000, and the fmv of his home was $90,000. Wilma has taken title to the home and is now looking into what to do. She has consulted you for advice on the taxation of her options.
The first option she is considering is simply walking away from the house, never going back, and allowing the bank to foreclose on it. She is concerned that this is a constructive sale to the bank, which, after foreclosure, will lead to the loan being cancelled, and that this debt cancellation will cause that amount to be deemed an amount realized, producing taxable gain.
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The second option is for her to offer to settle the loan with the bank at the home’s fmv, $90,000, and then staying in the home, herself. She is thinking of offering them cash in that amount in order to get the loan discharged. Again, she is concerned about the amount of the gains arising from this option.
The third option is for her to sell the house to neighbors who want to buy it for their son. She is considering negotiating with the bank to settle the mortgage for only $80,000, which, after selling the house for $90,000 and paying 7% realtors fees and closing costs, will net her $3,700. She is concerned about the amount of the gain she might have to report in this case.
Required:
1) Prepare a memo to the managing tax partner of your CPA firm in the format illustrated in the examples I have posted. Be careful to correctly cite court cases, statutes, regulations, revenue rulings, and all other materials that you use as shown in those examples and as described in chapter 2 of the text. You are to research this question thoroughly because your firm has determined that a number of clients may fall into this situation, and your memo is quite important. The starting point is the Crane, 331 U.S. 1 (1947), case. Also, read and integrate the Tufts case, 461 U.S. 300 (1983), as well as other relevant court cases, regulations, revenue rulings, statutes, etc. you find. You may do your research together with other students, but each student’s memo is to be prepared by them individually.
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2) What would you advise Wilma to do if the property had not yet been distributed her, and was still in the estate?
