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What Happens After Foreclosure?


March 18, 2011

If you’ve lost your home through foreclosure, there are potential tax consequences that you may have overlooked.

  • The cancelled debt may be taxable.
  • You may have a gain on the sale of the house, which in turn may be taxable.

Cancellation of Debt

If your lender cancels or forgives the mortgage you borrowed, you may have to include the canceled amount on your income taxes. Because you were obligated to repay the lender, you were not required to include the original amount that you borrowed as income on your tax return for the year that you began the mortgage. The amount you receive, when that debt is subsequently forgiven, generally means you must report it as income, because you are no longer required to repay the lender. The lender must send you a Form 1099-C, Cancellation of Debt showing the total canceled debt.

For example: You borrow $175,000 and default on the mortgage loan after making payments totaling $25,000. If the lender is unable to collect the remaining balance of the debt from you, a cancellation of debt of $150,000 is created, which could be taxable income to you.

Capital Gain

Even with a foreclosure, you may have still realized a gain on the property. If this occurs you will need to calculate the profits from the foreclosure by subtracting the amount realized from the sale from the adjusted tax basis of the home. The cost of improvements to the property in addition to the original price of the property is your adjusted tax basis. The difference between the gross proceeds and your adjusted basis will be your gain. In a foreclosure the amount realized depends a lot on whether your loan is recourse or non-recourse:

  • For recourse loans, if your home is sold at a foreclosure sale, the amount realized is its fair market value, which is generally the sales price minus expenses of the sale, such as court costs, legal fees and real estate commissions. If your mortgage is a recourse loan, you're personally responsible for repaying the bank or mortgage company. If you don't repay the loan, or default, the bank can sue you for the remaining amount due on your loan if the proceeds from a foreclosure sale doesn't cover the amount you owe.
  • For non-recourse loans, your amount realized equals the amount you owed on the mortgage plus any interest that comes due up to the time of the foreclosure. if your mortgage is non-recourse, your lender cannot make you pay the loan. The only thing it can do is foreclose and sell your house for payment on the debt.

Gratefully, there are other situations when cancellation of debt may not be taxable:

  1. If you have declared bankruptcy, the discharged debt is considered non-taxable.
  2. If your total debts are more than the fair market value of your total assets, you are considered to be insolvent and may qualify for an exemption.
  3. If you run a farm and the debt was incurred in the operation of it, you may also qualify for an exemption.

The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt that is reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure qualify for this relief. This provision applies to debt forgiven in calendar years 2007 through 2012. The exclusion doesn’t apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

Visit your local PRO-TAX location to get answers to your foreclosure questions, or any other tax-related questions you may have. Our staff want to help you through this difficult time, and make sure that you are taxed on the appropriate amount of income, and nothing more.