Foreclosure Tax Liability

By | May 5, 2010

Will I have a tax liability if I walk away from my home and let it go into foreclosure?

It seems like more and more homeowners are deciding to strategically default on their mortgage as they walk away from their underwater homes.  With real estate values plummeting and no end in sight for struggling borrowers, it seems like the smart thing to do is just leave it all behind.  But the facts are that people need to get educated on exactly what implications they may face in the future if they do decide to walk away from their debts.

Often when a homeowner goes through foreclosure or performs a short sale on their primary residence, the lender will usually cancel or forgive the debt and file a Federal form 1099-A, acquisition or abandonment of secure property, or form 1099 – C, cancellation of debt, that provide the amount of debt canceled, information to compute gain or loss, and whether the taxpayer is personally liable for the debt.  The reason they do this is because in most states, a purchase money loan is considered non-recourse . Hence, lenders would have no way to pursue these borrowers for a deficiency judgment to recoup their losses.  So, they essentially write it off at tax time and the tax ball is now in your court to prove to the tax man that this is not income.

The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from this discharge debt on their primary residence.  However, this law does not cover Investment Properties and second homes.  Those borrowers may have to pay income on this canceled that.

Please also be aware that you might have state taxes that may be due on this canceled that.  However, in states like California they have similar laws such as the Mortgage Forgiveness Debt Relief Act that which just extended by Governor Arnold Schwarzenegger on April 13 that allows taxpayers who had all or part of their mortgage balance on their principle residence forgiven by their lender to exclude the forgiven debt from California gross income.  The new law applies to discharged debt on primary residences only on or after January 1, 2009 and before January 1, 2013.  Please check with your state to see if you have a similar law that may protect you.  It is always wise to consult with a tax and real estate attorney when you are going through the foreclosure process to obtain the proper legal information to effectively protect you and your assets.