Tax Implications of Foreclosures and Deed-in-Lieu of Foreclosures


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There are a lot of people with upside down real estate facing the real possibility of just having to walk away from their properties. I just had a conversation about this very thing with a TaxLoopholes community member. She said, “I can’t get this information anywhere else” and that made me realize how important it is to put this out in one place so everyone has the facts.

I’m just going to talk about Foreclosures and Deed-in-Lieu of Foreclosure in this blog. There are also separate issues for Short Sales and Loan Modifications, but that’s for another day.

In the case of a foreclosure, you’re just walking away. At some point, you may or may not get a Form 1099-A which will report that the lender has received property during some kind of repossession or foreclosure process. The Form 1099-A has a box that indicates whether you received any cash as a result of this transaction. If it shows you have, than the IRS is going to expect you to report a taxable event on your tax return. You’ve gotten cash, and that is income.

You also may or may not get a Form 1099-C. The Form 1099-C reports debt forgiveness. That means that you owed more than the property was worth and the lender is just writing off the difference. In other words, they loaned you $300,000 to buy the property and it’s now worth $160,000. So they just took a loss of $140,000.

If they forgive the debt, they are supposed to issue a Form 1099-C. The amount of the debt forgiveness is taxable to you.

There is a way to not pay tax on that debt forgiveness amount, but I want to stop here for a minute.

The first word you need to remember: Estoppel. This is the ONLY reason why you should do a D-I-L. The lender wants you to do a D-I-L, it makes things easier, cheaper and gives them a much better chance of getting a house back in better condition. In exchange, you want to have them give you an estoppel. That means they will not come after you for the balance due.

Don’t be misled by a lot of fancy footwork here. They have 4 years to come back on you for that debt (in most states) and no matter what the customer service rep you’re talking to says, they are going to come after you for that debt as soon as they figure you are back on your feet.

Get an estoppel. That means they have forgiven the debt.

If you don’t get a Form 1099-C, that could be for any number of reasons: ( 1 )The lender’s records are a mess, ( 2 )They didn’t really forgive the debt, ( 3 )The Form 1099-C got lost in the mail or ( 4 ) Your dog ate your mail. (Or some other reason)

I think you still need to assume they are going to send you one. That’s because in the year that the debt is forgiven, you have a way out of the tax. If you have a principal residence debt forgiveness or are bankrupt or insolvent in the year of the forgiveness, you do not have to pay tax on the forgiveness. But you only get to take that exemption if you file Form 982.

There is a lot here in this blog post. More than anything else, it’s important to not ignore two things: Estoppel and Form 982. Those are the secrets to putting this bad real estate market behind you and not having ghosts pop up down the road.



2 Comments

  1. Megan Hughes says:

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  2. Lisa says:

    Hi Diane,
    I did a Deed in Lieu on my mortgage when I could no longer pay my mortgage. I received a 1099-A. Box 2 shows a balance of prinicpal outstanding of $80,849.84 and box 4 shows a FMV of property of $0.00. How do I report this on my taxes? Do I report this as income or the sale of my main home? I am so confused at this point! Any insight that you can offer would be greatly appreciated!