Foreclosure Consequences and Your Tax Liability

Foreclosure Home For Sale Real Estate Sign in Front of Beautiful Majestic House.

Foreclosure Consequences and Your Tax Liability

Foreclosure Consequences and Your Tax Liability

Foreclosure Consequences and Your Tax Liability

If you’re facing foreclosure, you need to know the foreclosing consequences that may follow – particularly, your tax liability. Here’s everything you need.

Not being able to pay your mortgage is tough. We’re not here to judge.

If you’re having trouble paying your mortgage, the first thing you may want to look into is how to refinance your mortgage to avoid foreclosure. You could also check out how to use government grants to save your home.

Does it seem like too much work to do these? Or too much money?

Well, if it’s at all possible for you to take either of these actions, they are well worth the time and money.

Because making the decision for go into foreclosure on your home or property carries with it consequences that go beyond just the emotional and physical.

And choosing to go into foreclosure doesn’t necessarily free you from the money concerns. Foreclosure consequences can be a heavy burden.

One of the heavier foreclosure consequences is tax liability.

If you or your lender eventually sell your property for less than you owed on it in a short sale or a foreclosure auction, the lender may go after you for the difference. This is known as a deficiency.

If you are fortunate to live in a state where the lender cannot sue you for the deficiency, this doesn’t mean you’re problems are over.

In these cases, the lender might forgive the debt.

It’s not as good as it sounds. There may still be foreclosure consequences.

You may be liable to pay income tax on the amount that was forgiven. This money is considered a gift and not something you have to pay back. Therefore, it is income.

The IRS is informed of a forgiven deficiency when it receives an IRS Form 1099C from your lender. This is a form on which a creditor reports to the IRS the amount of a loan as income that they no longer expect to be repaid.

Such is the situation with a foreclosure.

There are times when canceled debt is considered income.

As there are times when it is not.

Whether you’ll end up owing income tax on the amount of a forgiven deficiency will depend on your circumstances. The basic rules are as follows:

Loans for your principal residence.

Thanks to the Mortgage Forgiveness Debt Relief Act of 2007, most homeowners whose debt was forgiven in the calendar years between 2007 through 2014 are not required to pay income tax on the forgiven amount after a foreclosure of their principal residence. Plus,

  • If you file a joint tax return with your spouse, you can exclude up to $2 million of forgiven debt from your income. If you’re married and file separately, you can exclude up to $1 million.
  • You have to report the amount of forgiven debt on a special IRS form, and attach it to your tax return.

Unfortunately, the Act expired on December 31, 2014, and has not been extended.

Loans for other real estate.

If you default on a mortgage that’s secured by property that isn’t your primary residence – i.e. a second part-time residence – you WILL owe income tax on any forgiven deficiency.

So if, for example, you foreclose on a loan on a vacation home out in the woods, you can definitely expect a Form 1099C in the mail.

The same applies to loans used for non-residential real estate.

Loans not used for real estate.

We hope this one is obvious.

But if you take out a home equity loan and spend it on filling your closet with designer clothing rather than updating the closet, then chances are you’re going to owe taxes on the amount of forgiven deficiency.

So what happens if you do face income tax liability?

There are two possible ways to get out of paying those taxes.

The two options are the insolvency exclusion and bankruptcy.

1. The insolvency exclusion.

To use this, you’ll have to prove to the satisfaction of the IRS that your liabilities exceeded the value of your assets at the time your debt was canceled.

Essentially, canceled debt cannot be included in income to the extent you were insolvent.

2. File for bankruptcy.

When debt is wiped out upon filing for bankruptcy, that debt is no longer considered taxable income.

You will, of course, need to file for bankruptcy before your debt is canceled. And obviously, you’ll only want to file for bankruptcy if it makes sense for you.

Here’s another thing you need to consider:

Do you have a recourse or a non-recourse loan?

If your mortgage is a recourse loan, you will be personally responsible for repaying the bank or mortgage company. If you don’t repay the loan, the bank can sue you for the remaining amount due on your loan if what is made from the foreclosure sale doesn’t cover the amount you owe.

On the other hand, if your mortgage is non-recourse, the lender cannot make you pay the loan. The only thing the lender can do is foreclose and sell your house for payment on the debt.

Either way, the foreclosure is a taxable sale for you.

This is the case even if you give the lender a deed to your home in satisfaction of the debt, which is called a deed or transfer “in lieu of foreclosure.” Since the foreclosure is treated as a sale, you have to report any gain from the sale as income.

You’ll be taxed on that gain. Yet another foreclosure consequence.

Unfortunately, the reverse isn’t true. You don’t get a deduction for any loss that you might have as a result of the foreclosure.

Life can be so unfair sometimes.

If you are facing a foreclosure, just know that you are far from alone.

Foreclosures have been increasing on all types of properties, though the foreclosure consequences are certainly felt most profoundly by homeowners.

The prospect of losing your home is stressful. If you have questions about foreclosure like:

  • If I bid on my house at the foreclosure sale and win, can I still take advantage of the Mortgage Forgiveness Debt Relief Act?
  • If it’s just looking like I won’t be ablet to get caught up on paying my mortgage, do you think I should stop paying and force the bank to foreclose?

Please reach out to us with any questions you might have about foreclosure consequences. We will help see you through.


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