As you listen to the debate over the latest turmoil in the real estate market, you may wonder how losing a home in foreclosure proceedings could result in taxable income.
Unfortunately, unless Congress changes federal tax law, there are two ways.
Gain on foreclosure.
A foreclosure is treated as a sale. When the amount realized on the foreclosure is greater than your basis in the home, the resulting gain is generally subject to tax at capital gains rates. You can have a gain even though you receive no cash.
However, if you used the home as your personal residence, the home sale exclusion rules may apply. Under these rules, gains of $250,000 or less ($500,000 or less if you're married and file jointly) are partially or fully exempt from tax.
What if the foreclosure results in a loss? There's no tax, but also no benefit, because losses on personal residences are not deductible.
Cancellation of debt.
When a lender forgives all or part of the amount you owe on a loan you're personally liable for, the amount you no longer have to pay is considered income. There are exceptions, such as bankruptcy, insolvency, or a gifting situation, but in general cancellation of debt is taxable as ordinary income.
When you're not personally liable for the debt, different rules apply, though you may still realize gain on the foreclosure. The good news on this issue is that Congress is currently considering tax legislation that would ease the tax burden for taxpayers who lose their homes to foreclosure.
For more information about the tax impact of foreclosure, please call. We can explain the available options and their consequences.
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