Do I Still Have to Pay Taxes After a Foreclosure? The Answer Might Surprise You

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Foreclosure Tax Consequence: An All-Too-Common Problem Many Face These Days

People who fall behind on their mortgage payments face foreclosure and consequently lose their valuable property in that proceeding. After foreclosure, you are able to walk away from your mortgage payment scot free, but not from the potential taxes on the on the forgiven debt.

Why You May Owe the IRS After Foreclosure

If the lender sells your home for less than the amount that is owed on your mortgage, any pardoned debt can be treated as “earned taxable income.” What this means is that the IRS sees this as income that you ACTUALLY EARNED because it’s monies that the lender has said you don’t have to pay back; hence, it’s money in your pocket (at least theoretically speaking).

The tax that’s assessed is on the cancellation of this “forgiven debt” income. And FYI, this can occur if the bank forecloses, or if you do a short sale.

Short Sale or Foreclosure? Why Both are Subject to Taxes

Both produce “earned income.” The only difference is in how they do it.

A short sale is when the bank agrees to let you sell your home for less than what is owed. A short sale keeps a foreclosure from showing up in your credit report, but the shortfall will appear due to neglectful payment of loan.

In both instances (a short sale and a foreclosure), you are not paying the full amount owed on the loan; this portion is “cancelled debt.” And again, this cancellation of debt produces taxable income according to the IRS.

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What Happens If You Can’t Afford to Pay Taxes on “Income” Produced by a Foreclosure or Short Sale?

If the property owner (eg, you) fails to meet the financial obligation to the IRS, then the IRS may charge surplus interest. And, of course, there are penalties — and they can add up pretty quickly.

A Way Out: How to Avoid Paying Taxes after a Short Sale or Foreclosure

There is a possible way out of part or the entire tax obligation. What is it? In short, Form 982. Form 982 requires proof that you are bankrupt and you must provide all documents to support your claim of bankruptcy.

The consequences of foreclosure are not easy to swallow. That’s why — whatever your situation is — it’s best to consult a foreclosure attorney, a bankruptcy lawyer, or at the very least an accountant who’s knowledgeable about foreclosure.

Related Posts

Understanding Foreclosure Deficiencies and Mortgage Debt Forgiveness: Specific, Clear, Detailed Examples Given

Tax Consequences of Home Foreclosures & Short Sales: Note — 2012 Is a Critical Year for Homeowners Facing Foreclosure

Home Foreclosure and Taxes: Important Tax Consequences of a Short Sale after December 31, 2012

 How to Avoid a Deficiency Judgement After Foreclosure

Underwater On Your Home? Filing Chapter 7 Bankruptcy? Should You Reaffirm Your Mortgage?

Mortgage Foreclosure Timeline: How the Foreclosure Process Works & How Long You Actually Have to Move if You Eventually Lose Your Home

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About the Author: Pauline Go is an online leading expert in real estate law. She also offers top quality articles like: Unfair Eviction & Property Line.

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