There are many negative effects a foreclosure has on homeowners. You may think that your financial issues are almost over when you no longer have the large mortgage to pay. However, you may end up owing the IRS. If the lender forgives the debt on the home loan, the lender will usually report it to you and the IRS. This becomes taxable income also knows as foreclosure tax.
What is cancellation of debt?
Cancellation- of-debt is when a lender forgives or cancels debt after you default on a loan. You have to include the amount of cancelled or forgiven debt as income on your tax return. The reason is because you didn’t report it on your income tax at the time you borrowed the money. At the time you had an obligation to pay it back so reporting it wasn’t required. When you default on the loan and the lender forgives the debt, you have to report it as income because you’re no longer obligated to pay the loan. Lenders will usually report the amount of cancelled debt to you and the IRS on a form 1099.
Are there always tax implications when a lender cancels the debt?
There are some exceptions to taxing cancelled debt. The most common are bankruptcy, insolvency, and certain farm debts. Debts discharged under bankruptcy are not taxable income. Insolvency is when you’re debts are more than the fair market value of all your assets. If you can prove insolvency, then the cancelled debt won’t be taxable income. If your debt was directly due to operating a farm, over half of your income was from farming for the previous three years, and the lender was a bank or lender, it’s not considered taxable income.
What are the tax implications of a foreclosure?
In a foreclosure the lender will forgive some of the loan. The lender forecloses on the home and sells it for less than the loan balance or writes off the debt at the end of the year. Either way the lender will have to forgive part of the loan or the entire loan. The lender will issue a 1099 cancellation of debt form. Under the tax code it’s considered taxable income.
What is an example of foreclosure tax?
You took out a home loan and lived in it for 10 years. It was then taken through foreclosure by the lender. At the time of the foreclosure you had a balance of $150,000 on the loan and the lender sold the home for $100,000. The difference in the loan of $50,000 will be forgiven by the lender. However, the lender will issue you a 1099 showing the cancellation- of- debt and the IRS will get a copy. Now, you have an additional income of $50,000 that is taxable along with your regular taxable income.
Foreclosure tax comes into play when a lender issues a 1099 for cancellation- of- debt after foreclosing on your home. The 1099 is sent to you and the IRS. The amount reported on the 1099 is considered taxable income. You are responsible for paying the tax on the income in addition to your regular income.