When you run into trouble making your monthly mortgage payments, you may need to think twice about letting the house go into foreclosure. It may be better for you to find a way to get more income or have a short sale rather than facing the possible tax implications that come with losing your home this way.
In some cases, forgiven mortgage debt may be subject to taxes. Nolo reveals that most people who experience a foreclosure or short sale will not owe a tax liability through 2025. When a foreclosure occurs, the Internal Revenue Service (IRS) treats it as if you sold the property.
The Consolidated Appropriations Act
In December 2020, the Consolidated Appropriations Act (CAA) became law. TurboTax says this law removes up to $750,000 of canceled qualified mortgage debt from your income through 2025.A mortgage is not limited to the loan you obtained to buy the property. It also includes loans you took out to build a home or substantially improve one and any loan where a lender has an interest in your home.
Two Types of Mortgage Debt
When you take out a mortgage, you will get either a recourse or a non-recourse loan. Recourse debt means the lender can pursue the buyer for more than just the property in foreclosure. The buyer maybe liable to pay the balance owed after the property sells.A non-recourse loan limits the lender to only reclaiming the property. They cannot pursue the buyer for any other debt. This kind of debt protects the buyer and limits all possible liability.
Most mortgages, TheBalanceMoney says, are non-recourse loans. When you refinance or take out a home equity loan, they are usually recourse loans, but it may depend on the state where you live.
Short Sales and Foreclosures
A lender may permit you to run a short sale on your home. This type of sale lets you sell it for less than what is owed and cancels the remaining balance.A lender may also take the home from you in a foreclosure. It can occur when you fail to keep up with your mortgage payments.
Either event may make you liable for taxes. If so, the taxes are added to your ordinary income. When your home sells for less than the balance owed from a short sale or foreclosure, you may owe the balance with a recourse mortgage. Some lenders may forgive or cancel the balance—but you still may owe taxes on it.
The Tax Documents
After foreclosure and sale, TheBalanceMoney says you will receive either a Form 1099-A or a 1099-C, or possibly both. The 1099-A informs you of the foreclosure date, the property’s fair market value, and how much you still owe on the mortgage. You will use the information to report any capital gains made on the property.You will receive a 1099-C after a bank has forgiven or canceled the debt owed on a recourse loan. You could receive both forms if the home is foreclosed and the debt canceled.
The Mortgage Forgiveness Debt Relief Act
When the Mortgage Forgiveness Debt Relief Act passed in 2007, it enabled married couples filing jointly with foreclosures to take off from their taxable income up to $2,000,000 in discharged mortgage debt. Singles or married filing separately could reduce their taxable income up to $1,000,000.The exclusion limit was reduced in 2021 for a canceled mortgage to $750,000 for married couples filing jointly. Singles and married couples filing separately could reduce their canceled debt by up to $375,000.
Possible Reasons for Tax Exclusions
When there is a cancellation of debt from the lender, you will pay taxes on the amount that exceeds the exclusion amount. HRBlock says three possible exclusions would result in you not owing any taxes after the foreclosure. They include:- The debt is canceled as a result of bankruptcy proceedings (Title 11).
- The debt owed on a qualified principal residence was discharged before Jan. 1, 2026.
- Your debts are larger than your assets.
You may be able to exclude any capital gains involved. When you have owned the home for at least five years—up until the time of the foreclosure—and lived in it for at least two of those years, you can exclude up to $250,000 of the capital gains, and twice that if you are married filing jointly. Any amount that exceeds the exclusion amount must be reported as capital gains on Schedule D.
Losses on a Foreclosure and Taxes
After a foreclosure on your home, you may discover that you suffered a loss. Unfortunately, the IRS says that a loss obtained when a foreclosed home is sold is not deductible.What to Do When Facing a Foreclosure
If you are currently facing the possibility of foreclosure, there are several things you need to do quickly. You do not want to wait. The first thing you should do is to contact your lender. Ask about getting a loan modification or refinancing, which can restructure the loan and give you lower payments. You may also want to ask about making repayments to get caught up on back payments.Another option, QuickenLoans says, is to ask for a mortgage forbearance. If granted it will temporarily put your payments on hold for a limited period. When it ends, you are expected to pay back the missing payments.
When you think that you will not be able to get caught up on back payments, you can sign a deed in lieu of foreclosure. This method is you voluntarily transferring ownership of your home back to the lender, letting you avoid foreclosure.
If a foreclosure seems inevitable shortly, take action quickly to reduce or even eliminate the situation of possible tax implications and credit problems. Talk to a financial counselor to determine your best course of action.
The Epoch Times copyright © 2023. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
