Tax Consequences of Foreclosure

Many folks believe that if the bank takes a home back in foreclosure proceedings, that they are off the hook for any future liability on the home.

If you have watched your home disappear in the foreclosure process, you might have stepped back and thought to yourself, “Thank God, I am out, of this financial mess.”  Not so quick.

While you may no longer owe money to the bank on your home, you might discover that you owe the IRS, and it is never fun to owe the IRS money. When you walk away from debt owed, the bank views this transaction as income to you. The lender gave you money and the bank has “written off” the debt. 

You might reflect for a moment, and believe that the bank took the home back, and you no longer own it, therefore you should not owe any additional money. Again, not so quick. The bank took the financial loss, and you no longer own the home, but the IRS will not forgive this “gift”, from the bank to you.

The specific tax consequence of foreclosure will depend upon each defaulter, and each situation. Consult with a tax advisor for specific consequences.

If you owe 100,000 in a note on a home, and you owe 50,000 on the first mortgage, and 50,000 on a second equity line of credit, and you let this home go back to the bank in foreclosure, and the home sells via the bank for 50,000.00, there will probably be some tax consequences for you.

The bank may have written off $50,000, and this money will be considered income to you. The bank gave you $50,000, in a “credit” so to speak, and it is considered income. You will be taxed as if you earned $50,000, as if you received free money,  from the bank.

While you may not have received this income in cash, it is income because the bank took the hit, and you received the credit. 

Check with your accountant for details specific to your unique situation, but don’t be surprised if you have tax consequences for letting a home go back in foreclosure proceedings.

Always consult with an accountant prior to foreclosure, to best evaluate the taxes that you may owe to the IRS, should you let the home proceed in a foreclosure.