Tax Implications for Property Foreclosures
Economic conditions as of 2010 have brought up a technical tax issue that all homeowners should be aware of. Depending on the circumstances, former homeowners can still possibly be liable for taxes when their house is foreclosed. Further, an individual's taxes will change along with his homeownership status. Thus, it is beneficial for homeowners to understand tax implications before they change their ownership status.
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Receiving a Benefit
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When a house or property is foreclosed, it is the most obvious phase in the process of a bank or lender taking over ownership of the property. Generally this occurs when the owner has taken out financing to pay for the property, using the purchased home or structure as collateral to guarantee the loan. If the loan then defaults, the lender can take over the property.
However, if the owner walks away in a foreclosure and the bank writes off the remainder of loan owed, then the owner receives a financial benefit. According to the Internal Revenue Service (IRS), the owner is then liable for the taxes owed on the loan difference that is forgiven. This is considered taxable income that is required to be reported.
Short Sales Are Also Taxable
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An alternative in foreclosure is when the bank, in the midst of the foreclosure proceedings, agrees to a short sale. Lenders are not interested very much in actually owning property, so in a pending default they can be inclined to sell the property to at least get some of their money back. A short sale sells the home or property to a third party for less than what is still owed.
If a bank or lender accepts a short sale in lieu of a foreclosure, then the former owner is liable for taxes on the remaining amount of the loan that is not settled by the short sale and is forgiven by the lender. Again, this is considered reportable income for taxes.
Only when a former owner is insolvent and the difference gained wipes out remaining liabilities will the IRS make a temporary exception to the normal income reporting from a foreclosure benefit. This exception was mandated by the Mortgage Forgiveness Debt Relief Act of 2007.
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Loss of a Deduction
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During foreclosure, the last thing people think about is their tax deductions. However, it is a fallout factor that needs to be considered. Many people bank on receiving a certain level of tax refund every year. When a home with a mortgage is lost in a foreclosure, the former owner can no longer claim mortgage interest or property tax paid as a deduction on his taxes. This downstream impact will create a loss of funds that the former owner previously relied on. For some it can be a rude surprise after the foreclosure fact.
Property Taxes May Still be Owed
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Former owners who go through foreclosure may still find themselves owing property taxes after the fact. First, property taxes are charged to the owner of record at the time the tax bills are issued. Even though a foreclosure may have occurred weeks after the fact, the former property owner still owes the taxes charged on record.
Further, many times property records take a while to update. A foreclosure may have occurred prior to billing but the local government in charge does not have updated records. The tax bill will still be sent to the former owner. The local government tax office will need to be corrected with valid title documentation showing title has changed.
Conclusion
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In short, just because a property is lost to foreclosure does not mean the former owner is now absolved of tax responsibilities. Owners and soon-to-be foreclosed parties should pay close attention to the tax ramifications of foreclosure. If possible consult with a tax expert to understand all the possibilities that may occur in an individual case before committing to them.
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