12 Jun Can I Owe Tax If I Lose My Home to Foreclosure?
Strange as it may seem, you can end up with a tax bill if you settle a debt for less than the full amount due or if your home, or other property, is foreclosed or sold without full payment of the loans against it.
Federal tax law provides for tax on debt that is canceled or forgiven without full payment. Unless you fit within one of the exceptions allowed by the IRS, the loss of your home could result in tax due.
Tax on canceled debt is not new. However, it has not been much of a problem for consumers in the past. I have written articles about debt cancellation tax and some of the ways it can be avoided.Mycolleagueshave answered the question “What is debt cancellation tax” in others.
Several factors have combined to make this ironic problem a consumer issue. The run up of home values in recent years and the aggressive marketing of home loans, often to people who can not afford to pay them have combined with new computer technology used by the IRS to pinpoint transactions when debt is canceled. The result has been the issuance of tax due notices to increasing numbers of financially distressed consumers.
The housing bubble is over but not forgotten. Easy home loans are a thing of the past. Like a great party that was just too much fun, the morning after can leave quite a hangover. About 10 years ago the IRS started to require all banks and most other consumer lenders to report when a debt is canceled without full payment. For several years now lenders are required not only to report the interest you pay them but to report any debt they cancel in connection with your loans.
In December of 2007, Congress passed the Mortgage Foregiveness Debt Relief Act of 2007, it offered a window of protection from tax for homeowners who only borrowed against their home to buy it in the first place or to remodel. It was originally set to expire at the end of 2009 but was extended through 2012 when congress passed the TARP legislation.
Other exceptions to the debt cancelation tax available to homeowners are the bankruptcy exception and the insolvency exception. However, the debt cancelation must be reported on the tax return using the appropriateform or the IRS will assume no exception applies and send a notice thatcan lead to the assessment of additional tax.
What can you do if you may lose your home to foreclosure? There are two main ways to deal with the problem. First, if the loanin foreclosure involves money you used to buy the home or for a major improvement of your home, the Mortgage Foregiveness Debt Relief Act will probably apply andno tax will be due if the return is properly prepared.
As an alternative, if the loan was a refinance and you used some of the loan money to pay other consumer debt, bankruptcy may be your best option. Timing is important and if a foreclosure of your home is in process, talk to an attorney immediately. Bankruptcy is only helpful in avoiding tax if a discharge is entered before the debt is otherwise disposed of by the foreclosure.
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