When A Mortgage Exceeds The Market Value Of House

Q: We bought our home in the mid-1980s when market values were going up every year. But that stopped in our neighborhood about 1990. We refinanced our home in 1990 to combine our first and second mortgages.

In 1993, we tried to refinance again to reduce our interest rate, but the mortgage lender's appraiser said our home is worth less than our current mortgage balance. So we dropped the refinance idea.

But last January, my husband's employer of 23 years gave him the choice of transferring to Tampa or losing his job. We agreed the transfer is best, as we hear Tampa is a nice place to live.

But our problem is the mortgage on our home is more than the house is worth today. My husband's employer won't assist with our loss, although their relocation company will buy our house at its market value.

If we sell, our tax adviser says we cannot deduct our loss on our tax returns. Should we walk away from our home, sell at a loss, or is there another alternative?

A: If it's any comfort, thousands of other homeowners are in similar situations - their home was worth more in the past than it is worth today.

Although you said if you sell you will have a loss, that is probably not correct. I doubt your home's market value has declined to the purchase price you paid in the mid-1980s. I think you meant it isn't now worth its 1990 appraised value.

However, if you elect to sell, the house will probably sell for less than your mortgage balance. That means you will have to come up with more cash to pay off the mortgage balance.

Unfortunately, this amount is not tax deductible. The reason is that you have already received the cash from the mortgage loan.

Also, you should be aware you probably have an excess mortgage. That means the mortgage balance exceeds your home's adjusted-cost basis.

If you sell the house, you will probably have a taxable profit since the net adjusted sales price will surely exceed your adjusted cost basis (purchase price plus capital improvements you added).

The bad result will be a tax due but no cash with which to pay it.

Another alternative is to stop making mortgage payments, walk away from the house, let the lender foreclose, ruin your credit, and possibly incur liability for the lender's loss deficiency. I do not recommend this alternative.

Still another choice is to rent the house to tenants if you think its market value might recover to at least the amount of your mortgage balance in the next few years.

To obtain enough rent to pay the mortgage payment and property taxes, I recommend a lease with option to purchase.

Be sure to give a substantial rent credit toward the buyer's down payment, such as 33 to 50 percent of the rent paid. The higher the rent credit, the greater the probability the tenant will exercise the option to buy.

When the tenant exercises his/her option to buy, you can then defer your profit tax by purchasing a qualifying replacement home in Tampa.

A lease-option is a far better alternative than the adverse consequences of walking away from your mortgage. Please consult your tax adviser about the advantages of renting your former residence.

Q: When we had our income tax prepared, the tax preparer took the amount of property taxes off our year-end statement from our mortgage lender.

But we actually paid into our escrow impound account about $300 more than the lender shows. When I phoned the lender, I was told the amount on our statement is what was paid in 1993 to the tax collector.

Why can't we deduct the higher amount we actually paid into our escrow account?

A: The two major itemized income-tax deductions for homeowners are mortgage interest and property taxes.

Many mortgage borrowers, like you, have escrow impound accounts where they pay one-twelfth of their annual estimated property taxes and homeowner's insurance premiums each month. Then they do not have to pay these bills in large lump-sum payments.

But most mortgage lenders estimate these bills on the high side to assure there will be an adequate reserve in your escrow impound account if the taxes and insurance costs increase.

That is why you paid about $300 more into your escrow account than was actually remitted to the local tax collector.

However, you can only deduct the actual amount paid to the tax collector, not the larger amount you paid into your escrow account. Sorry, your tax preparer is correct.

(Copyright, 1994, Tribune Media Services Inc.)

Bob Bruss' column appears Sundays in the Home/Real Estate section. His mailing address is: Bob Bruss, Seattle Times Newsroom, P.O. Box 70, Seattle, WA 98111.