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Tax Consequences of Foreclosure

foreclosure

The Mortgage Debt Relief Act of 2007 essentially allows taxpayers to exclude income from discharging debt on their principal residence. You’ll want to check the details of the exclusion to see if you qualify for this form of tax relief… and do the math.

Use this equation provided by the IRS to compute the income to be reported from a foreclosure:

1. Enter the total amount of the debt immediately prior to the foreclosure.

2. Enter the fair market value of the property from Form 1099-C, box 7.

3. Subtract line 2 from line 1.If less than zero, enter zero.

    The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C.  This amount is taxable unless you meet one of the exceptions.

4. Enter the fair market value of the property foreclosed. For non-recourse loans, enter the amount of the debt immediately prior to the foreclosure.

5. Enter your adjusted basis in the property (i.e., your purchase price plus the cost of any major improvements).

6. Subtract line 5 from line 4.  If less than zero, enter zero.

The amount on line 6 is your gain from the foreclosure of your home.  If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income.  If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses. Losses from the sale or foreclosure of personal property are not deductible.

Here’s a sample case provided by the IRS that equates to tax relief:

A borrower bought a home in August 2005 and lived in it until it was taken through foreclosure in September 2007. The original purchase price was $170,000, the home is worth $200,000 at foreclosure, and the mortgage debt canceled at foreclosure is $220,000. At the time of the foreclosure, the borrower is insolvent, with liabilities (mortgage, credit cards, car loans and other debts) totaling $250,000 and assets totaling $230,000.

Now, to figure the income from this foreclosure using the above formula:

1. Enter the total amount of the debt immediately prior to the foreclosure. $220,000

2. Enter the fair market value of the property from Form 1099-C, box 7. $200,000

3. Subtract line 2 from line 1.If less than zero, enter zero. $20,000

    The amount on line 3 will generally equal the amount shown in box 2 of Form 1099-C.  This amount is taxable unless you meet one of the exceptions in question 2.  Enter it on line 21, Other Income, of your Form 1040.

4. Enter the fair market value of the property foreclosed. For non-recourse loans, enter the amount of the debt immediately prior to the foreclosure. $200,000

5. Enter your adjusted basis in the property (i.e., your purchase price plus the cost of any major improvements). $170,000

6. Subtract line 5 from line 4.If less than zero, enter zero. $30,000

The amount on line 6 is your gain from the foreclosure of your home.  If you have owned and used the home as your principal residence for periods totaling at least two years during the five year period ending on the date of the foreclosure, you may exclude up to $250,000 (up to $500,000 for married couples filing a joint return) from income.  If you do not qualify for this exclusion, or your gain exceeds $250,000 ($500,000 for married couples filing a joint return), report the taxable amount on Schedule D, Capital Gains and Losses.

In this situation, the borrower has a tax-free home-sale gain of $30,000 ($200,000 minus $170,000), because they owned and lived in their home as a principal residence for at least two years. Ordinarily, the borrower would also have taxable debt-forgiveness income of $20,000 ($220,000 minus $200,000). But since the borrower’s liabilities exceed assets by $20,000 ($250,000 minus $230,000) there is no tax on the canceled debt.

Other examples can be found in IRS Publication 544, Sales and Other Dispositions of Assets, in the section titled “Foreclosures and Repossessions.”

Get Help

IRS Tax Relief Now specializes in tax resolution and IRS representation. You don’t have to deal with the IRS alone and it’s generally not recommended. Hire an Enrolled Agent because of their familiarity of the IRS. Enrolled Agents are the only tax professional licensed by the IRS to represent taxpayers. In addition, the IRS requires Enrolled Agents to actively remain abreast of the most recent tax laws in order to maintain their license. No other tax professional is held accountable for their tax knowledge and representation like the Enrolled Agent.

Our Enrolled Agents have several years of comprehensive experience with the IRS. We hold an A+ rating at the Better Business Bureau and invite you to see it for yourself through the link posted on our home page. Our tax professionals do not adhere to business hours. Our schedules are arranged so that someone is available to chat with you 24 hours a day, seven days a week. Contact us today for your free evaluation of your tax issue. You have nothing to lose and you’ll sleep better tonight. We’re waiting for your call.

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