Tax Question??

Question

If I lose my home to Deed in leui of foreclosure, is there a chance I will owe tax on this as taxable income? If so, how do I know? What kind of percentage would I be looking at? The house is worth 92,000 and I owe 97,000. They are forgiving the entire debt. Any scenarios? Would I qualify for the mortgage forgiveness act? Thanks!

Answer 1

You really need to provide further information so we can deal with what is instead of what if.  Was this your main home?  Did you own it for more than two years? What did you originally pay for the house and did you sink any money into improvements?  Is your basis more than what you had forgiven on it?  See how one question and its answer spawns two questions to take its place?

Answer 2

There are two tax issues at hand in a foreclosure situation.  

First off, the foreclosure is treated as any other sale.  The amount of the outstanding mortgage is the sales price.  If your basis is less, then the gain is taxable unless you owned and lived in the home for 2 of the 5 years immediately prior to the sale where you can exclude the gain from tax.  If any capital gains tax is due, there is NO way out of paying it.

Secondly is the issue of the Cancellation of Debt or COD as it's sometimes called in "tax speak."  If this was your principal residence and the foreclosure occurred in 2007 or later you may be covered by the Mortgage Forgiveness Act provisions.  That ONLY gets you off the hook for COD income.  

If this was an investment property or the foreclosure took place prior to 2007, the MFA does not apply so you would have to resort to the old rules.  Under the old rules, COD income does not apply if you are insolvent at the time of the COD. That is, if your liabilities exceed the value of your assets you are considered insolvent.  Any COD income is ignored, up to the amount of your insolvency.  You'd file Form 982 and a balance sheet showing your assets and liabilities to exempt the COD income from tax.

Answer 3

In addition to what Bostonian said: For the COD to be forgiven it must be a nonrecourse loan. Most home acquisition loans are nonrecourse. Refis are a different story. If your refi is a recourse loan it does not qualify for the forgiveness program and must be included in income. Most refis are recourse loans. The bank, if they wish, can sue you for that part.