J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

31.15 Transferring Mortgaged Realty

Mortgaging realty that has appreciated in value is one way of realizing cash on the appreciation without current tax consequences. The receipt of cash by mortgaging the property is not taxed; tax will generally be imposed only when the property is sold. However, there is a possible tax where the mortgage exceeds the adjusted basis of the property and the property is given away or transferred to a controlled corporation. Where the property is transferred to a controlled corporation, the excess is taxable gain. Further, if the IRS successfully charges that the transfer is part of a tax avoidance scheme, the taxable gain may be as high as the amount of the mortgage liability.

Charitable donations.

The IRS holds that a donation of mortgaged property to a charity is a part-sale, part-gift, and the donor has taxable gain to the extent the mortgage liability exceeds the portion of the donor’s basis allocable to the sale part of the transaction (14.6).