Negative Equity: A Tale of Death, Taxes, and Moving On
From the planning side, Diane’s mother could have tried to provide Diane with sufficient cash, or “liquidity,” to pay off the mortgage. One common way to create liquidity in an estate is to purchase life insurance on the testator’s life. Many estate planners also advise their clients to allow significantly encumbered real property to pass into their residual estate and to give away percentages of the residue. This can be preferential to a specific bequest because it provides greater assurance to the testator that the beneficiaries will receive something of value (as opposed to a condominium worth less than the principal balance of its mortgage).
Addressing Diane’s predicament, she should be aware that her options are few and potentially expensive. Notwithstanding the Garn-St. Germain Act, Diane likely cannot assume her mother’s mortgage; even discussing the loan with the bank may be impossible due to privacy concerns. But one way or another—either on her own or through her mother’s estate—she must deal with the lender. As her counsel, you need to help her negotiate from the strongest position possible.
Diane could pay off the mortgage, but this option doesn’t make much economic sense because the assessed value of the condominium is less than the principal balance of the loan. Another option is to contact the lender (likely through the personal representative of her mother’s estate) and essentially negotiate a mortgage reduction. Diane’s chances for success with such a negotiation may increase if she threatens to disclaim the condominium, leaving it in an estate lacking the resources to pay off the mortgage and leaving the lender with a non-performing loan.
Few tax issues arise from Diane’s receipt of the condominium. Assuming Diane is unwilling to pay off the loan, any mortgage debt cancellation should flow to the estate and potentially could be excluded as income from discharge of indebtedness under the Mortgage Forgiveness Debt Relief Act of 2007.
William H. Glasson is an associate with Scarborough, McNeese, O’Brien & Kilkenny, P.C., in Portland, OR. Contact him at firstname.lastname@example.org .
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