Forgiven but not forgotten
In many cases, the tax problem associated with a foreclosure arises from a seemingly benevolent move — the lender forgives some of the loan. This happens when a lender and a borrower negotiate a reduction in loan amount. It also happens when the lender forecloses on the property and sells it for less than the outstanding mortgage.
In both instances, the difference for which the borrower is no longer responsible is usually considered cancellation of debt, or COD income. It also is called discharge of indebtedness income or discharge of debt. Regardless of the name, under the tax code, it’s all taxable income. The tax on COD is calculated at ordinary rates, which range from 10 percent to 35 percent depending upon your income.
Possible Congressional help: As for taxes on foreclosures, there might be some legislative relief from D.C. on the way.
Back in April, Rep. Robert E. Andrews, D-N.J., introduced the Mortgage Cancellation Tax Relief Act of 2007 (HR 1876). On the other side of Capitol Hill, Sen. Debbie Stabenow, D-Mich., introduced an identical version, S. 1394. Both measures would amend the tax code to make debt forgiveness on principal home mortgages nontaxable income.
Since the bills were introduced back in the spring, they have been languishing. No hearings, nothing, by either the Ways and Means or the Senate Finance committees.
But given what’s going on, and likely to keep going on for a while, with mortgages and unexpected taxes, that might soon change.
Foreclosure’s Costly Tax Implications