Do you have to pay taxes is forclosed on and it does not sell for what you owe your?

Question

mortgage company. I heard that if the mortgage company accepts a lesser amount than what you owe that a 1099 will be sent to you and the IRS and that the difference is considered taxable income. example, owe $160,000 mortgage and house sels for $100,000 at a sheriff's sale. Would 60,000 of that be considered earned income? Thanks.

Answer 1

There are 2 separate tax considerations on a foreclosure or short sale.

First off, a foreclosure or short sale is a sale, pure and simple. It's entirely possible to have a taxable profit on the foreclosure or short sale. Say that your basis in the house was $30,000 and you didn't qualify for the exclusion of the gain on the sale of a personal residence. You'd have a $70,000 capital gain to pay taxes on. (And there's no way out of that tax bill, it WILL have to be paid!)

Then there is the issue of any shortfall on the mortgage. If it's a non-recourse mortgage you have nothing to worry about. The approved short sale (or ordinary foreclosure) wipes out the excess debt and that's that.

If it's a recourse mortgage, then any shortfall is considered taxable income to you. In your example, it would be $60,000 assuming that all of the numbers here are net of all expenses. However, there IS a way out of paying tax on that in some cases. If you are insolvent at the time of the foreclosure or short sale, the amount forgiven up to the amount of your insolvency, is not taxable. If you filed bankruptcy it would be presumed that you were insolvent. However you don't need to take that drastic measure. If the value of your debts exceeded the fair market value of your assets at the moment of the short sale or foreclosure, you'd be considered insolvent and some or all of the forgiven debt would not be taxable.

Claiming insolvency is a bit tricky and it would be worth every penny to pay a pro to prepare your tax returns this year. You'll need to generate a balance sheet showing your insolvency and unless you are experienced in preparing financial statements the money you pay a pro will be well spent.

Answer 2

The difference you describe is subject to tax. It is unearned income, so you pay income tax on the amount, but no Social Security or Medicare taxes.

If you are bankrupt or insolvent at the time the loan is forgiven, you may be able to escape taxes on the forgiven debt. Consult a tax advisor if this applies to you.

Answer 3

That is correct. What you describe is the alternative to the mortgage lender holding the borrower responsible for the $60,000 shortage.