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Tax Consequences of a Home Foreclosure

A home foreclosure is treated as a taxable transfer of your home. It is possible that you could have income from this transaction and need to pay taxes, which would likely be taxed at the capital gains rates.

However, there are some cases where you may be able to exclude the sales proceeds from income and avoid paying the tax. You should also understand whether cancellation of debt income could be relevant to your foreclosure.

Income From the Foreclosure

The IRS considers a foreclosure as a sale for tax purposes. If the fair market value of the property exceeds your adjusted basis, you may have a taxable gain.

Your basis is generally the price you paid to purchase the home plus the cost of any additions or improvements. Subtract this amount from the fair market value of the foreclosed property to determine your gain.

You may qualify to exclude up to $250,000 ($500,000 if married from jointly) of this gain from your income. You’ll need to meet all of the following conditions to be eligible:

  • You lived in the home for two of the past five years.
  • You owned the home for two of the past five years.
  • You haven’t claimed the exclusion for the sale of another home in the past two years.

If you can’t exclude all of the gain, you’ll likely owe capital gains tax. The current capital gains tax rates are 20%, 15%, or 0%, depending on how much taxable income you have.

Cancellation of Debt Income

You may also have cancellation of debt income if the mortgage loan was a recourse loan. With this type of loan, you are personally liable for the debt even after a foreclosure.

Most first mortgages are not recourse loans. However, a refinanced loan or a home equity loan may be a recourse loan in some cases. You may receive a Form 1099-C if the lender cancels the balance of your debt after foreclosing on the home.

Your cancellation of debt income will be taxable unless an exception applies, such as debt canceled during insolvency or in a bankruptcy case. 

If you owe taxes from a home foreclosure, make sure you understand your repayment options, including IRS installment agreements and Offers in Compromise. Contact a tax attorney to determine your best tax resolution strategy.

The Gartzman Law Firm handles tax debt settlement, penalty abatement, and other tax resolution cases. Use our contact form to request a consultation with an Atlanta tax resolution attorney.