Foreclosures and Taxes Consquences
If you think that you can escape the IRS when you decide to foreclose on your house, think again, there can be huge tax disadvantages to letting your house go back to the bank, it can mean thousands of dollars you could owe to uncle Sam.
Many homeowners bought their house under creative financing terms such as interest only and variable rate loans. With the recent shakedown of the mortgage industry and rates adjusting, it can be a recipe for disaster for homeowners. You can owe the IRS in one of two ways, which we will discuss in detail.
When a bank forecloses on your property and sells it for less than what you had originally owed on it, then you are responsible for the difference, which is taxable.
The other way in which you will owe taxes is when the bank forgives part of the balance, this is taxable as well. In the eyes of the Internal Revenue Service, this is COD or cancellation of debt income or discharge of debt income, as it is often called.
The tax rate can be as high as 35% depending on the tax bracket that the homeowner falls in. Tax law directs homeowners to actually sell their home back to the bank which the proceeds will go to their debt. The actual tax rate could be as low as 10%, but again it depends on your tax bracket the amount that the homeowner will owe at tax time.
Many homeowners have been wrongly informed that debt discharged by the bank is not fully taxable, when in fact it is. They have been given, often times, bad advice by a loved one or someone else who does not know the law, but they will need to pay the IRS for the discharged debt at their current tax rate.
The tax consquences should always be considered when turning your keys back into the bank, it is never as easy as it seems, and homeowners could potentially get a huge tax bill at the end of the year if they are not careful.
