tax liability on foreclosure

[freshstart05]

My scenario - I filed Ch 7 in 2004 and my debt was discharged in 2005. I decided to keep my home (thought I could manage the mortgage payments). After the Ch 7 discharge I refinanced my house and cashed out some equity so that I could afford to continue the mortgage. I am no longer with my employer and am moving out of state. My house is on the market, I am current on the mortgage payments however I don't think that I will be able to sell for what I owe. If the house goes to foreclosure, I have read that the bank can buy the house for $1 and would send a 1099 that would leave me with a huge tax liability between what is owed and what it is sold for.

Would love to have advice from anyone who has been through a similiar situation or who might be experienced with this type of situation.

[Me!]

You may want to check out the following blog entry from Credit Slips.

http://www.creditslips.org/creditslips/2007/08/lets-give-the-i.html

From what I have read, the cancellation of debt (COD) income that is reported on the 1099 should be the amount of debt less the FMV. However, if the bank undervalues your property (for example, reporting the $1 paid at foreclosure), then you have a fight on your hands...

[tay666]

Check your state's foreclosure laws also.
I know in Ohio a house can't sell at auciton for less than 2/3 or what is owed on it.
So, if you owe $30,000 on the house.
The bidding at the sheriffs sale starts at $20,000.

[HHM]

Honestly, even if the bank pulled something like buying the house for $1, I can't imagine that would create any tax liability for you. There are really only 2 scenarios (note, I am simplifying here) where the individual has tax liability related to a home.

1. Sale of the home for a profit. If you sell your home and make a profit (i.e. the house is sold for more than you bought it for), you would be taxed on that profit (note, there are tons of offsets that you can apply).

2. In a short sale...i.e. when you sell your home for less than you owe, and the bank accepts the short sale, meaning they will accept less money then they are owed. In that scenario, you will get a 1099 for the difference between what the bank was owed, and how much they actually got. And even in this scenario, you can get out of paying this tax if you can demonstrate to the IRS that you were insolvent at the time of the transaction (I forget the form number you have to fill out for this).

In a foreclosure, all bets are off. You don't get any "income" tax liability on a foreclosure sale because a foreclosure sale is NOT DEBT FORGIVENESS. Debt forgiveness tax liability only arises when both sides agree...both parties must act voluntarily (i.e. debtor, voluntarily, pays less than what is owed, and the creditor, voluntarily, accepts less than owed). Foreclosure is not "voluntary" on the debtors part, so you don't get debt forgiveness tax liability.

Note, the real estate transaction gets reported to the IRS, but that does not mean you will be liable for any tax.

[Me!]

I did a little more digging on this one...

IRS Publication 544 (http://www.irs.gov/pub/irs-pdf/p544.pdf

http://biz.yahoo.com/brn/070824/22944.html?.v=1

Hope this helps...

[supastar84]

In relevance to this question, I want to get some others thoughts on something.....So there are three things that may happen in the foreclosure process (if you are goal is to get rid of home):

-short sale
-deed in lieu of foreclosure
-foreclosure

I don't see how a homeowner benefits from doing a shortsale. Basically you are just left with C.O.D. income, assuming the lender does what it is supposed to do a sends a 1099C. And really, the same goes for deed in lieu. Usually in deed in lieu you may be able to get the lender to promise not to come after defiency judgment, but you are still creating tax liability.

From my research and personal experience, and from a tax standpoint, foreclosure is the only logical thing to do. I guess you are still left with possible tax liability, depending on what the lender decides to put in the "FMV" box on the 1099A. What are others thoughts on this?