Upcoming Foreclosures

What is the tax liability if an property through foreclosure is lost. For example:?

Cost basis is 50k the loan on property is 50k but lender foreclosed for 55k because of interest owed and attorney costs. Is taxes owed on 55k? This is a bazaar situation since the bank got the property back hasn't the owner lost a 50,000 dollar asset?? Isnt there a loss and a taxable gain here. I am confused my friend thinks he is going to owe a lot of money when he received no cash in hand and never got paid in the first place? By the way for this example assume the owner held the property for more than one year.

Public Comments

1. ok the bank foreclosed they now own and will resell it at some price. If you live in a recourse state and the property sells for less than full then the old owner will pay the loss the lender incurred. The very least he will get a 1099 for the lenders loss and then face the IRS
2. A foreclosure is nothing more than a specialized type of sale. All of the normal rules for sale of an asset apply just at they would have with a normal sale. The outstanding loan balance (which may include unpaid interest but not other fees) is the selling price. The original basis is what it is. Subtract the basis from the selling price to get the gain or loss on the sale. If the taxpayer owned and lived in the home as their principal residence for 2 of the 5 years prior to the sale the exclusion rule applies and as long as the gain is less than the applicable exclusion amount ($250k for Single or $500k for MFJ) the sale is not even reported by the taxpayer and no tax is due. If capital gains taxes are due on this gain, there's no way around them; they must be paid. This is a separate issue from cancellation of debt income, covered next. The next issue is what happens to the unpaid balance of the mortgage once the lender sells the property. If the mortgage is a non-recourse mortgage then whatever the lender recovers at sale is all that they are entitled to and no cancellation of debt income issues arise. If the mortgage is a recourse mortgage the lender is entitled to recover their losses. If they can not recover they may forgive the balance owed and write it off a uncollectible. When they do that they will cut a Form 1099-C to document the canceled debt. That COD may be taxable income to the taxpayer. If the mortgage was for the purchase of the home (or a refi with no equity cash out) and the mortgage was foreclosed upon in 2007 or later and the home was the principal residence of the taxpayer then no COD income is taxable under the Mortgage Debt Relief Act of 2007. If the MDRA does not apply (such as for rental or investment property or a cash-out refi or HELO) then the old insolvency rules may apply. To the extent that you are insolvent, no COD income is created. That requires you to work up a simple balance sheet showing the value of your assets and a list of your liabilities. If you owe more than you own, you are insolvent. To the extent that you are insolvent, no COD income is generated. (Don't forget to include the COD amount as a liability when figuring your insolvency!) Exemption of COD income from taxable income is claimed on Form 982, whatever means you are claiming it.
3. Your example is missing quite a bit of information. Eg, I buy the house for $80K with $30K down and get an interest only mortgage. I screwup and lose the house to foreclosure. The bank issues a 1099-A for loan balance of $50K, showing FMV at $50K and whether or not the loan is recourse. If it's recourse, I'll get a 1099-C for $5000 and will be unable to deduct the $35K loss. If it's non-recourse, I won't get a 1099-C.