At a foreclosure, the lender can make a profit or it can take a loss, depending on whether the home sells for more than the outstanding loan amount. Either way, there have been taxation ramifications for the previous homeowner, even though the creditor is the one who has technically made or lost money.

Foreclosure Profit

In the event of a foreclosure in which the creditor makes a profit, the Internal Revenue Service (IRS) treats the profit for a capital gain for the homeowner, even though he did not get the money. It isn’t important whether the homeowner gets the cash or not–the advantage (home) sold at a profit and resulted in a profit. Federal tax law excludes the first $250,000 of profit from the sale of a home ($500,000 for spouses filing jointly) from taxation, therefore the average homeowner would likely pay taxes in this scenario.

Foreclosure Loss

If the foreclosure sells for less than the loan amount, the creditor requires a loss. It can then turn around and sue the debtor for the difference between the loan amount and the sale price of the home. The debtor can’t declare this money for a reduction on his taxation, according to the IRS.

Debt Forgiveness

Sometimes the creditor requires a reduction because of a foreclosure or short sale, but forgives all or part of their borrower’s debt. At the end of the calendar year, the creditor sends the debtor an IRS form 1099-C. The sum declared by the lender on this form is included as taxable income on the borrower’s tax return. Because of the rash of foreclosures from the late 2000s, Congress passed the Fund Forgiveness Debt Relief Act of 2007 to pay foreclosures happening from 2007 to 2012. Under this action, if a foreclosure is accompanied by a reduction of value that forces a property to sell at a reduction, the forgiven debt is not treated as taxable income.

Capital Benefits on a Loss

A borrower might nonetheless be liable for taxation on a home that falls beneath the Mortgage Forgiveness Debt Relief Act of 2007 when she originally purchased the home for less than the foreclosure cost. Most homeowners took out second mortgages and home equity loans that raised the loan amount on the home. While the home may be worth less than the outstanding loan balance, the homeowner nonetheless shows a profit within his initial purchase price. This is a capital gain and the debtor is liable for taxation on gains over $250,000 ($500,000 for spouses filing jointly).

Foreclosures and Bankruptcy or Insolvency

Borrowers are not liable for any debt forgiveness that’s a portion of a bankruptcy or occurs during bankruptcy (complete debt is more than total assets, such as retirement and investments). The borrower’s debt must not happen to be forgiven before declaring bankruptcy or becoming insolvent in order to be tax exempt. IRS Form 982 is utilized to show insolvency prior to debt forgiveness. Advice from a certified public accountant or tax attorney can help in determining the best plan of action concerning tax implications of foreclosure.

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