How do I pay off losses at a home sale?

January 11, 2008 7:45 PM

What is the best option for paying off a mortgage when I take a loss on a condo sale - and are there any tax deductions I can take?

Long story - but basically I'm looking at losing about 20% on a condo in a sale. Its been for sale for 2 years, we're paying two mortgages, and I need out. If it does sell, I'm going to owe 20-30k at closing, after losing all the equity I put in.

What is the best option for paying off the mortgage:
1) Borrow against my retirement account, pay myself back at ~6% interest for 4 years- interest goes to me (company run retirement acct)
2) Get a home equity loan or 2nd mortgage on our current house.

Problem with #1 is the long term hit to my retirement account, because savings aren't growing while borrowed. Problem with #2 is that it just transfers debt to our second home, and if we sell it, we're back in the same boat of owing this money.

I'm leaning towards option 1.

Bonus question: Is there any way I can get any tax benefits from this loss? As I read the IRS regs, I can't deduct home sale losses. Any options here?

Relevant facts: we are early 30s, condo was my bachelor pad, great place in a terrible neighborhood that hasn't taken off, and comps have dropped significantly in the last few years. Renting it is an option, but I lose ~$500/month on the mortgage at the rent I could get for it.

posted by reckman to work & money (6 comments total)

Mail the keys in and walk away - defaulting now gets you nice tax breaks and you are staring down the road to repair quicker. Things will only get worse through... 2010?... and you'll be getting further and further underwater the whole time. Cut your losses now.

Home loss tax write-off information from USA Today.
posted by unixrat at 8:47 PM on January 11

I'm not sure that you're looking at this exactly right. You probably understand that the interest that you pay yourself on the "loan" from your retirement savings, while possibly important to you in personal cash flow terms, is more or less irrelevant.

To really answer this question (assuming throwing the keys at the bank and telling them to pound sand, which you may be able to do if you live in a non-recourse state, and you're willing to torch your credit) we need to know some details about what you'd do with the excess cash flow that you'll (probably) have by taking the HELOC over the retirement loan, what your monthly spending requirement is (and willingness to sacrifice is) in relation to your income, what your tax situation looks like, what the rate, terms and deductibility of the HELOC are, and how your marginal retirement dollar is invested.

Believe it or not, this is a very simple problem to solve in Excel once you understand what it is you're trying to optimize and what your constraints are. But we're missing most of that data.

I suspect that anyone who tells you that this is entirely open and shut isn't considering the whole picture.
posted by Kwantsar at 9:33 PM on January 11

You can't deduct losses on the sale of a personal residence, but you should have been deducting the interest and property taxes you have been paying on a second home. If you convert your condo to a rental, you can deduct the loss when you sell, but only on the loss that occurs from the time you start renting it. You can't deduct the loss in value that occurred over the last few years while it wasn't a rental.

Mailing the keys and walking away is a complicated question and depends on a lot of factors. First it depends on whether you have a recourse or non-recourse loan. If it is a recourse loan, then the bank can come after your other assets to make up for the loss they took when they short sold your home. In some states you may have a non-recourse loan which means that they can't collect their losses on the short sale. But that just means they may not bother to try to sell. They will just force you to keep paying the mortgage by keeping the loan in effect since selling terminates their rights to collect from you. You should definitely talk to a real estate lawyer before attempting this route. Of course this will ruin your credit for a while but it might be the only reasonable alternative.

Another possibility is to talk to your lender and see if you can make some sort of deal, either a reduction in interest rate, paying interest only, or maybe splitting the difference on the loss of a short sale.

As far as borrowing from a 401k vs. a home equity loan, you have to compare the rate your investments earn in the 401k vs the cost of the HELOC. The 6% or whatever you pay yourself is irrelevant because you are paying yourself with your own money so ignore that. Assume that your HELOC costs you 9% and you are in the 25% bracket, your cost of borrowing after the interest deduction is 6.75%. Compare this to what you think you can conservatively earn in your 401k. If it is more than 6.75%, then go with the HELOC. If it is less than 6.75% you are better off borrowing from the 401k. And don't fool yourself by thinking you can conservatively earn 10% in your 401k.

But there is one very important danger about borrowing from your 401k. If you lose or change your job for any reason, you have to pay back the entire amount you borrowed from your 401k within 30 days or so. If you can't come up with the cash, you have to pay both the taxes and a 10% penalty on the shortfall. If you lose your job, you may not be able to borrow the money on short notice. Not a pretty picture.
posted by JackFlash at 11:03 PM on January 11

JackFlash - I did not know that I can deduct the loss when its a rental... I'll go read up on that. Its been "for rent" and listed with agents for over a year - but no takers. I will have to see if that qualifies.

I realize I didn't give enough info for anyone to do the math, and I appreciate all the comments. And I'm not going to nuke my credit with a foreclosure - bankruptcy isn't on the horizon, but the extra payments are keeping us tied to our jobs and location.
posted by reckman at 4:49 AM on January 12

I'm doubt just having the condo listed "for rent" qualifies as conversion to rental property unless it has actually been rented or even if rented for just a couple months before the sale.

Whatever you decide to do you have a lot of money at stake and a lot of choices. It would be well worth consulting a tax professional and/or real estate lawyer.
posted by JackFlash at 9:39 AM on January 12

I'm actually going to second talking to your lender. My understanding is that they're in a pretty tight spot right now, and the truth of the matter is that they don't want your real estate because they can't sell it either. I think some of them are starting to explore pretty dramatic loss mitigation options, so maybe they can do something for you.
posted by hue at 10:24 AM on January 12