Foreclosure is something that no one ever wants to deal with. They do not want it on their permanent record list and they don t want the embarrassment that comes with losing their house. A foreclosure can stay on your record list for as long as seven years. It will also make it next to impossible to get another mortgage in the future. While the issue of the foreclosure is bad, many people are so far behind on their mortgage, they are ready to put it behind them. They want to just get out of the house, move into a nice apartment and put it behind them. The psychological burden that is lifted off of their shoulders can feel great. While it can help for some people to get a fresh start, you might be surprised to learn that the foreclosure comes with a huge tax bill.Why would you have to pay taxes on a foreclosure? Here are a few things to think about when dealing with foreclosures and taxes.
When you experience a foreclosure, the lender is taking back the house. They will also cancel the debt that you owe to them. They will take back the house and there may be a difference in the price. If your house is worth less than what the mortgage really is about, it s almost like they re giving you money. This cancelled debt can be considered income in the eyes of the IRS.
Let s just say that your mortgage was for $200,000. Then property values plummeted and your house is now worth only $150,000. You lose your home to foreclosure and the bank takes the house back. They cancel the $200,000 mortgage and sell the house for $150,000. You just made $50,000 on that transaction because the bank cancelled the debt. Therefore, you might have to pay taxes on $50,000 worth of income.
This rule is very similar to when you negotiate your way out of a credit card balance or another account. When the company that you owe money to takes less than you owe, you have to count the difference as income.
There are some different ways to get out of this rule. For one thing, if this is your primary residence, there is a good chance that you ll be allright. If you have lived in the house for at least two out of the last five years, you will not have to pay any capital gains taxes up to a certain limit. If you are married, you can gain up to $500,000 in capital gains without paying taxes on it. If you are single, the exception is $250,000. Therefore, unless you gained a lot of money on the house, you should be able to get out of paying any taxes.
Before you go through foreclosure, it is a very good idea to get the advice of a certified tax professional. They can help you navigate through the confusion that comes with foreclosures and tax law.
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