Will It Affect My Taxes If My Property Forecloses?
- You're excluded from owing income tax on forgiven debt that had your principal residence as collateral. In addition, you must have incurred the debt to buy, build, or substantially improve your principal residence. This law is set to expire after 2012. Until then, you can exclude up to $2,000,000 of canceled debt from foreclosure of your principal residence. A married person filing a separate tax return is limited to an exclusion of $1,000,000.
- The exclusion doesn't apply to cancellation of debt secured by your primary residence that was incurred for purposes not related to the house. For example, you're taxed on canceled debt consisting of a loan used to pay off other debts---such as credit cards---despite the loan having your home as security. In addition, no relief from owing income tax on forgiven debt applies to loans canceled due to foreclosure on vacation homes, rental property, or business property.
- The exclusion only applies when the discharge of debt is directly related to a decline in the home's value. Consequently, there is no income tax effect if the fair market value of your principal residence at the time of foreclosure is less than the total amount you paid to buy, build, and improve your home.
Lenders use Form 1099-C to report forgiven debt. This form shows the amount of canceled debt and the fair market value of property obtained in a foreclosure. - You don't owe income tax on any debt that's discharged in a bankruptcy or due to insolvency. To report insolvency, you submit Form 982 to the Internal Revenue Service. You show on this form that your assets were exceeded by your total liabilities at the time of the debt cancellation. That condition of insolvency permits you to exclude from taxable income a canceled loan obtained for any purpose, including debt secured by foreclosed property other than your principal residence.
