How Does Foreclosure Affect Your Taxes?

How Does Foreclosure Affect Your Taxes

If you’re struggling to pay your mortgage and are worried about foreclosure, you likely know that if the bank forecloses on your home, your credit will suffer. But a drop in your credit rating and worthiness isn’t the only negative consequence you might endure.

If your lender repossesses your property, you could also face costly federal and/or state tax implications. Depending on the size of your outstanding mortgage balance and the fair market value of your home at the time of foreclosure, your tax bill could significantly reduce or even wipe out any tax refund you may otherwise be due.

Read on to learn how taxes on home foreclosures work so you know what to expect if the bank relieves you of your house.

Forgiven Debt and Taxable Income

As far as the Internal Revenue Service (IRS) is concerned, if you have your outstanding mortgage debt forgiven by the lender, you’re essentially making money. That money is considered income, and that income is taxable.

When you think about it, it makes sense. If you no longer owe $80,000 on your house because the bank foreclosed on it, that’s $80,000 you essentially put back in your pocket. After all, you won’t need to spend that $80,000 in the future to pay back your loan.

If your lender forecloses on your property, they must report forgiven debt in excess of $600 to the IRS on a Cancellation of Debt form. The IRS considers that money “cancellation of debt income,” so you must report that income to the IRS on your federal taxes. You may also need to report it on your state taxes.

What Kind of Taxes Might You Need to Pay?

The IRS treats foreclosure as the sale of a home for tax purposes. That means you may need to pay taxes on your forgiven debt if you realized a capital gain as a result of your mortgage debt being canceled.

However, the capital gains tax exclusion may apply to you if the home that was foreclosed was your primary residence. If that’s the case, you’ll be able to exclude $250,000 (if you’re single) or $500,000 (if you’re married and file jointly) of capital gains from your taxable income.

When Canceled Debt Isn’t Taxable

Although forgiven debt generally must be reported as gross income on your taxes, there are a few situations when canceled debt is not considered taxable. These situations include:

  • Insolvency. If your total debts exceed the fair market value of your total assets at the time your mortgage debt is forgiven, your canceled debt (either in part or in full) may not be taxable. It’s a good idea to work with a tax professional if you think this situation might apply to you since insolvency is complicated to determine.
  • Bankruptcy. Debts discharged via bankruptcy, including mortgage debt, are not considered taxable income in the eyes of the IRS.
  • Nonrecourse loans. If you took out a recourse loan to purchase your home, you are personally responsible for paying back the loan in full — even if the lender forecloses on your house. If the foreclosure sale of your house doesn’t cover the full amount of your outstanding mortgage balance, you’ll have what’s called a deficiency, which your lender can sue you for.
  • Certain farm debts. If your home is part of a farm, and the bank forecloses on your house and cancels your outstanding mortgage balance, that forgiven debt may not be considered taxable income in the eyes of the IRS. However, tax rules surrounding farm debts are complex, so you’ll want to work with a tax professional to determine what your tax responsibilities are.

Sell Your House Fast With We Buy Salt Lake City Houses

If you’re facing foreclosure and don’t want to suffer the tax or credit consequences of having your home repossessed, get in touch with our team at We Buy Salt Lake City Houses. We buy houses in any condition and can help you sell your house fast. With our team, you can get out from under an overwhelming mortgage in a matter of days, and we’ll pay you cash at closing.

To learn more about how we buy houses and what you can expect, call us today at 385-900-2274. Or feel free to contact us online to request a no-obligation offer, and we’ll get in touch with you promptly.