CMPS Mortgage and Tax Strategies 3 — Questions and Answers
Question 1: A borrower's home was destroyed in a federally declared disaster. They received $40,000 from insurance but had an adjusted basis of $30,000 in the property. Which IRS code section allows deferral of the $10,000 gain?
- Section 1031
- Section 121
- Section 1033 (Correct answer)
- Section 179
Correct answer: Section 1033
Section 1033 allows deferral of gain from involuntary conversions (including casualty losses) if the proceeds are reinvested in similar replacement property within the required period.
Question 2: A self-employed borrower deducts a home office that equals 20% of their home's square footage. What portion of mortgage interest is deductible as a business expense?
- 100% on Schedule A
- 20% on Schedule C, 80% on Schedule A (Correct answer)
- 20% on Schedule C only; no Schedule A deduction for the remainder
- None; home office deduction eliminates mortgage interest deduction
Correct answer: 20% on Schedule C, 80% on Schedule A
The business-use percentage (20%) of mortgage interest is deductible on Schedule C, while the remaining 80% can still be deducted on Schedule A as home mortgage interest.
Question 3: Which mortgage structure allows a retiree to receive tax-free loan proceeds while deferring repayment until the home is sold or they move out?
- Cash-out refinance
- Home Equity Conversion Mortgage (HECM) (Correct answer)
- Shared appreciation mortgage
- Wraparound mortgage
Correct answer: Home Equity Conversion Mortgage (HECM)
A HECM (reverse mortgage) allows eligible homeowners 62+ to convert home equity into loan proceeds that are not taxable income and require no monthly repayment while they live in the home.
Question 4: A taxpayer is in the 32% marginal bracket and pays $20,000 in mortgage interest. Assuming full deductibility, what is the after-tax cost of that interest?
- $20,000
- $13,600 (Correct answer)
- $6,400
- $14,400
Correct answer: $13,600
The tax savings equal 32% × $20,000 = $6,400, so the after-tax cost is $20,000 − $6,400 = $13,600.
Question 5: When a lender forgives part of a mortgage balance through a short sale, what IRS form does the lender issue to report the cancelled debt?
- Form 1098
- Form 1099-C (Correct answer)
- Form 1099-A
- Form W-2G
Correct answer: Form 1099-C
Lenders report cancelled or forgiven debt of $600 or more on Form 1099-C (Cancellation of Debt), which the borrower must generally include in taxable income unless an exclusion applies.
Question 6: The Mortgage Forgiveness Debt Relief Act exclusion for a primary residence requires that the forgiven debt was used to:
- Pay off credit cards secured by the home
- Buy, build, or substantially improve the primary residence (Correct answer)
- Invest in income-producing assets
- Consolidate student loans
Correct answer: Buy, build, or substantially improve the primary residence
The exclusion applies only to acquisition debt—funds used to buy, build, or substantially improve the taxpayer's primary residence—not to cash-out debt used for other purposes.
Question 7: A homeowner converts their primary residence to a rental for 3 years and then sells it. They previously lived there for 4 years before converting. Is the Section 121 exclusion available?
- Yes, fully available because they lived there 4 years
- Yes, but prorated for the non-qualified use period after conversion (Correct answer)
- No, any rental use disqualifies the entire exclusion
- No, they must have lived there within the last 2 years of ownership
Correct answer: Yes, but prorated for the non-qualified use period after conversion
Post-2009 rules require proration: gain attributable to non-qualified use (rental period after conversion) is excluded from the Section 121 exclusion, but qualified-use gain may still be excluded up to the limit.
CMPS Mortgage and Tax Strategies 3
A borrower's home was destroyed in a federally declared disaster.
They received $40,000 from insurance but had an adjusted basis of $30,000 in the property.
Which IRS code section allows deferral of the $10,000 gain?