Are you behind on your mortgage? Worried your lender might foreclose on your house? Then it’s important to understand that the implications of foreclosure extend beyond a negative mark on your credit report. A foreclosed property may also affect your tax liability if you had a net gain as a result of foreclosure.
Because the Internal Revenue Service (IRS) treats a foreclosed house exactly as it treats a sold property, foreclosure may trigger capital gains. Depending on the circumstances, you may be liable for additional income taxes after the foreclosure is complete.
How does the whole process work? What might you be responsible for? In this blog, the home-buying experts at Purple Mountain Holdings share a brief overview of the tax implications of home foreclosure.
Foreclosure and Capital Gains Tax
The IRS considers a foreclosure as a “disposition of property,” meaning the property changed hands. Since you once owned the home and no longer have possession of it, the IRS still considers a “sale price” on the property for the purpose of income taxes.
That sale price may be the fair market value of the property on the date of foreclosure, or it could be the remaining mortgage balance immediately before the foreclosure took place. It all depends on whether you have a recourse or non-recourse loan.
You’ll use the sale price of the property to calculate your capital gains, which will determine whether you owe additional income taxes as a result of foreclosure. The type of loan you took out to purchase your house will determine how the IRS treats your taxes after foreclosure.
Foreclosure on a Non-recourse Loan and Tax Liability
If you have a non-recourse loan, that means you aren’t personally liable for repayment of the debt. In this case, the sale price on the property is your remaining loan balance immediately prior to the foreclosure.
When your home is repossessed, your loan is then considered satisfied, and the lender cannot pursue you for further payment. The IRS considers repossession on a non-recourse loan as full “payment” of outstanding debt since you’re essentially selling the house back to your lender to satisfy the remaining portion of the loan.
With a non-recourse loan, you won’t have any cancellation of debt since your debt is considered satisfied as of the property repossession. With no debt cancellation, you typically won’t have any capital gains either. Therefore, you likely won’t owe any additional income taxes as a result of foreclosure.
Foreclosure on a Recourse Loan and Tax Liability
If you took out a recourse loan to purchase your house, you are personally liable for your remaining mortgage debt. Per the terms of your loan, your lender can continue to pursue you for repayment of that debt even after the house is repossessed.
When you have a recourse loan, the sale price of the property is the lesser of:
- The fair market value of the house on the date of the foreclosure
- The remaining loan balance immediately prior to the foreclosure, minus any amount you remain liable for immediately after the property transfer
As a result of the foreclosure, you may end up with canceled debt income when you have a recourse loan. That basically means that the debt you owe was forgiven even though you’re personally liable for it.
Since you essentially made money off the debt cancellation, you may be responsible for paying income taxes on it. In addition to canceled debt income, you may also have capital gains on the property, which may require additional income taxes.
For a more in-depth breakdown of the tax calculation process on a foreclosed property, you can browse the Home Foreclosure and Debt Cancellation page on the IRS website.
Trying to Avoid Foreclosure? Contact Purple Mountain Holdings
If you need to sell your house fast because you’re trying to avoid foreclosure, get in touch with our team at Purple Mountain Holdings today. We’re cash home buyers and can purchase your house in as-is condition, for fair market value, in just a matter of days. To find out what we can offer you for your Colorado Springs home, give us a call today at (719) 476-2727, or submit your information to request a no-obligation cash offer.