If You’re In Foreclosure, Don’t Forget Tax Consequences of Getting Out of It
It’s been said that the economy is improving, and there’s no better indication of that than the fact that foreclosures are generally down. But they haven’t disappeared forever. And if you’re in foreclosure and looking at options to get out of it, the last thing that may be on your mind may be taxes.
But taxes are an important consideration, and one that homeowners must consider, especially when doing a short sale.
Short Sales and Deficiency Waivers
In a typical foreclosure, if the bank obtains your home, and the property sells at a foreclosure auction for less than the judgment, you may be personally liable for the difference. This is often called a “deficiency.” So, for example, if your home sold for $200,000 at foreclosure, but the foreclosure judgment was $300,000, the bank has a right to come after you personally to pay that $100,000 deficiency.
Deficiencies were a huge cause of personal bankruptcies during the crisis, and they continue to be even today, as foreclosures continue to be filed.
To avoid these deficiency judgments and bankruptcy, many homeowners in foreclosure opted to perform “short sales.” In a short sale, the bank will often agree to let you sell your home for a sale price less than the judgment, and allow you to walk away, never owing the difference.
And, in addition to a short sale, banks have offered thousands of people waivers of deficiency simply in return for agreeing to a foreclosure judgment. The “just leave and you owe us nothing” approach offered by banks has been taken up by thousands of Florida homeowners.
Taxes and Forgiven Debt
The tax code generally provides that excused debt is considered income. This is why if you ever settle a credit card debt for less than what you owe, you may get a 1099 for that “income.”
Normally, the tax code would treat your forgiven deficiency as income as well. This means that although you may have walked away from owing the bank $100,000, you would owe the IRS $20,000-$30,000 in taxes for that “income.”
But to ease the blow to homeowners dealing with foreclosure, congress enacted the mortgage forgiveness relief act. The Act excused homeowners from paying taxes on forgiven mortgage debt on homestead property. The Act made short sales and deficiency waivers much more practical, and prevented homeowners from getting the double hit of a foreclosure and then a huge tax bill.
Only recently did Congress extend the Act to cover 2014 transactions, meaning that 2014 deficiency waivers for homestead properties won’t be taxable. But congress thus far refused to extend it to 2015, and there’s no indication whether they will or not.
For borrowers, the tax consequences of forgiven debt must now be considered. It’s arguable whether you’d rather owe a bank, which is subject to state collection laws, or owe the IRS, with their considerable collection powers. Some would definitely prefer the bank.
Congress may, at some point, excuse 2015 debt. But the fact they could have done so now, but did not, may also be a sign that the willingness to provide such assistance to homeowners by Congress may waning.
If you have questions about the tax ramifications of any lawsuit, settlement, or other decision, don’t manage complex tax laws yourself. Contact Tampa will, probate and tax attorney David Toback to discuss your situation.