One of the unfortunate side effects of the recession is that many people have suffered a foreclosure. I have had clients asking me about the tax consequences of a foreclosure, and worrying about how that will affect their taxes.
The good news for homeowners is that they do not have to pay tax on any debt that is forgiven as part of a foreclosure on a principal residence. This applies to foreclosures happening in 2007-2012.
Note that this only applies to foreclosures on principal residences, and only to mortgage amounts that were used to buy or make improvements to the home. If you refinanced your mortgage and used some of the proceeds for other purposes, such as paying bills, and then suffer a foreclosure, you might have taxable income to report.
Also, forgiveness of other types of debt, such as credit card debt, is always treated as taxable income to you (unless you are insolvent or in bankruptcy).
While you may not be taxed on the debt forgiven in a home foreclosure, you do still have to report the amount of forgiven debt by attaching Form 982 to your tax return.
And even if the forgiven debt is not taxable, you may still have to report a capital gain on the mortgage forgiveness. The amount of gain or loss will depend on whether or not you were personally liable for the mortgage, the amount of debt forgiven, the fair market value of the house, and your basis in the house. If you suffer a capital loss on a foreclosure, the loss is not deductible.
As you can see, at its most basic level, a home foreclosure is simple – you aren’t taxed on any debt forgiven. But your reporting requirements can be complex. If you are going through a foreclosure, you should seek out a professional tax preparer such as myself to help you with your tax and reporting obligations.