Tax Implications

Mortgage Foreclosure Tax Implications - When a homeowner faces foreclosure, he or she may have certain tax implications that must be met. To determine whether a homeowner will face federal income tax consequences as a result of facing foreclosure, one must determine whether a mortgage is recourse or non-recourse. A recourse mortgage is one in which the property is worth less than the total loan balance after an auction has occurred, and a homeowner will likely face tax implications. A non-recourse mortgage is one in which a lender must resort to repossessing a home to recover funds from a homeowner. When a non-recourse loan is forgiven, cancellation of debt income does not result. There are no tax implications for a non-recourse loan.

Fair Market Value Amount - For recourse mortgages, a property that is sold at foreclosure is deemed to be treated as a sale of property for a fair market value amount. If the fair market value of the home is greater than the basis, then a homeowner will owe taxes. There are ways for a homeowner to legally avoid having to pay the taxes that are owed. For example, home sale gain exclusion may allow a taxpayer to exclude gains of up to $250,000. This means that a taxpayer will not have to pay any taxes on amounts that do not exceed $250,000. A married couple is able to exclude up to $500,000 for the home sale gain exclusion.

Qualifying for the Home Sale Gain Exclusion
After a foreclosure sale has occurred, a homeowner will want to make sure that he or she meets the legal requirements before using the home sale gain exclusion and filing income taxes. To qualify for this exclusion, a homeowner must show that he or she owned a home for two years of the previous five-year period from the date of foreclosure. Also, a homeowner must show that he or she used the home as a principal residence for at least two years in the previous five years. If the basis of a property exceeds the fair market value, then a nondeductible loss will go into effect for the taxpayer.