Question

I have a question about home foreclosure and taxes. What are the tax implications of foreclosure?

Answer

It is natural to be concerned about home foreclosure and taxes you may be responsible for. There might be two possible tax implications of foreclosure. It depends on if:

  • Your home is repossessed due to foreclosure.
  • Your mortgage debt is wiped out — also called cancellation of debt.

Foreclosure

The foreclosure itself is treated as a sale of the home. So, you might need to report it on Schedule D. You should receive Forms 1099-A with information about the sale.

What you’ll report as the amount realized on the sale depends on which of these applies:

  • If you were personally liable for the loan. This is called a recourse loan.
  • If you weren’t personally liable for the loan. This is called a nonrecourse loan.

On a recourse loan, the amount realized on the sale is the lesser of:

  • The outstanding debt right before the foreclosure. Subtract any amount for which you remain liable right after the transfer.
  • The fair market value (FMV) of the property transferred

On a nonrecourse loan, the amount realized on the sale is the full amount of the debt outstanding. This is as calculated right before the foreclosure.

You might be able to exclude the capital gain under the sale-of-principal-residence exclusion if both of these are true:

  • You have a gain on the sale.
  • The home was your main home.

Cancellation of Debt

If you were liable for the loan, you might have cancellation of debt income. You should receive a Form 1099-C with this information. This is usually the total amount of debt owed right before the foreclosure, minus the property’s FMV.

Cancellation of debt income from property secured by a recourse debt is taxable. This is true unless an exclusion applies. There are exclusions for these:

  • Debt cancelled in a bankruptcy proceeding
  • Qualified principal residence indebtedness
  • Insolvency (your debts are more than your assets)

Report any exclusion on Form 982.

 

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