Academic journal article William and Mary Law Review

The Tax Consequences of the Statutory Right of Redemption in Property Foreclosures

Academic journal article William and Mary Law Review

The Tax Consequences of the Statutory Right of Redemption in Property Foreclosures

Article excerpt

TABLE OF CONTENTS

INTRODUCTION
 I. THE HOUSING AND FORECLOSURE BOOM
II. FUNDAMENTALS OF PROPERTY OWNERSHIP
    A. Mortgages
       1. Recourse Lending
       2. Nonrecourse Lending
    B. Foreclosures
    C. Statutory Right of Redemption
III. INCOME AND THE STATUTORY RIGHT OF REDEMPTION
    A. Income
    B. Basis and Debt
    C. Statutory Redemption's Effect on Income
       1. Recourse Scenarios
       2. Nonrecourse Scenarios
       3. Income Recognition
IV. DEPRECIATION AND THE STATUTORY
    RIGHT OF REDEMPTION
    A. "Breaking the Chain"
    B. "Bridging the Gap".
    C. Bridging the Gap over Breaking the Chain
CONCLUSION

INTRODUCTION

In November of 2001, the National Bureau of Economic Research officially declared the U.S. economy in recession. (1) To counter this lull and restore strength to a struggling economy, the Federal Reserve began a series of interest rate reductions (2) that would lead to the lowest mortgage lending rates in forty years. (3) Almost immediately, the housing market responded. From 2002 to 2005, the U.S. economy moved from recession to expansion, sustained primarily with the aid of a housing boom. (4)

It is no secret that market conditions over the past five years have made it easier than ever to own a home. (5) What is not so well known is that these same conditions have also compounded the problem of foreclosures. In recent years, foreclosure rates have increased dramatically. (6) But, should the housing market contract, or in other words, should the proverbial housing bubble burst, (7) foreclosures could reach record levels. (8)

With foreclosures come statutory redemptions. The statutory right of redemption allows a borrower who lost her home at foreclosure to buy back her home within an allotted period of time, which ranges from thirty days to two years depending on the state redemption statute. (9) Because conditions are primed for a foreclosure boom, the need to address statutory redemptions is both relevant and timely.

This Note looks at one unaddressed aspect of statutory redemptions, namely the tax consequences and treatment of property redeemed after foreclosure. More specifically, this Note focuses on statutory redemption's effect on income, income recognition, and depreciation.

Part I will begin by discussing the housing market and the factors that have contributed to the current state of foreclosures. Part II will then provide a background of those principles relevant to property ownership and taxation, including mortgages, foreclosures, and the statutory right of redemption. Part III will discuss the effect of the statutory right of redemption on income as it applies to taxation. Part III will also address the element of income recognition, focusing on when income arising from the discharge of indebtedness as a result of statutory redemption should be recognized. Part IV will then analyze the effect of the statutory right of redemption on property depreciation. Part IV's analysis will first address the arguments for "breaking the chain" of depreciation in statutory redemptions, then address the arguments for "bridging the gap" in such depreciation, and finally conclude that "bridging the gap" should be preferred over "breaking the chain."

To help illustrate the principles discussed herein, this Note will use the following hypothetical as a reference throughout the text: Borrower (B) buys a house from Seller (S) for $100,000; and B finances the purchase through Lender (L) who loans B $90,000, with B using her own money to pay the remaining $10,000. (10)

I. THE HOUSING AND FORECLOSURE BOOM

Low interest rates over the past five years have resulted in a boom in both the housing and lending industries. (11) Borrowers have taken advantage of low rates by purchasing homes at record pace, by refinancing, by taking out home equity loans, and by purchasing additional properties as investments. …

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