Tax Tips
Foreclosure and Your Tax Bill
You may qualify for tax relief. Here's how to get it.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
February 24, 2009
If you were among the millions of homeowners caught in the mortgage foreclosure fiasco or who if you have had your debt reduced through a mortgage restructuring, you may qualify for special tax relief when you file your 2008 tax return.
Normally, if a commercial lender cancels a portion of your mortgage debt through a transaction known as a "short sale" or your debt is wiped out in a foreclosure, the forgiven debt is considered taxable income. Congress approved legislation in 2007 that excludes up to $2 million of indebtedness if it is secured by a principal residence. Last year, lawmakers extended the homeowners' relief through 2012.
For example, say you bought a home several years ago for $500,000 and last year it was worth $350,000. But your mortgage balance was still $450,000 and on top of that, you lost your job. With no way to make the monthly mortgage payments and no hope of selling your house in a depressed real estate market, you hand the deed back to the bank and walk away.
From a tax standpoint, two things happened. Your lender canceled $100,000 worth of debt and you realized a $150,000 loss on your house. Luckily, you qualify for the principal residence indebtedness provision and can exclude the $100,000 worth of canceled debt -- normally considered taxable include -- on your 2008 tax return.
Use Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness) to report the cancellation of $100,000 worth of debt. You reduce the basis in your home by the same amount. So instead of a $150,000 loss on the sale of your home ($500,000 purchase price minus the $350,000 value at the time of foreclosure), you now have a $50,000 loss ($150,000 minus $100,000 in canceled debt.) It won't affect your taxes because losses on the sale of a principal residence are not deductible any way. Bottom line: the foreclosure has no impact on your 2008 tax bill.
The tax relief does not apply to vacation or other second homes or to "cash out" refinancing that went to pay for other purchases or to wipe out credit card debt. "It will only help those who borrowed too much to acquire, build or improve a principal residence," says Robin Christian, Senior Tax Analyst for the Tax & Accounting business of Thomson Reuters.
There are other exceptions, too. Seller-financed mortgages -- meaning the home’s prior owner loaned you money to buy the house -- are not covered by the cancellation of debt provision. And debts discharged through bankruptcy are not considered taxable income.
Reader Comments (1)
Posted by: Hector Zansky at 12/09/2009 04:17:09 AM
Hi there, I found your posting very helpful and would like you advise on my situation...I bought a duplex house for $475 on Sep'07 and now it is $260 and I still owe the same $475K. I live in one unit and rent the other on and off as tenant move out. I spent about $30K fixing the rented unit and I only made about 20K in rental income since I bought this Duplex. I am planning to foreclose as I can not afford it anymore due to employment and serious family sickness. What are the Tax consequences if lender(s) 1st and 2nd issue a 1099C for the total of $215K given that I have declared the second unit as a rental in 2007, 2008, and 2009 income taxes? Do I still qualify for the Tax Relief or does the Tax Relief gets prorated just because I rented the other unit, thus forcing me to pay some taxes even though I had loses every year in the rental unit after all the repairs that were done? I will greatly appreciate your advice as I am going through one of the hardest times of my life with losing my house and family sickness. Thanks, Hector