Tuesday, March 4, 2008

Foreclosure and the IRS: How can You Avoid Owing the IRS after You Lose Your Home

Things aren't looking so good... According to government, statistics home foreclosures are at an all-time high. Millions of Americans have no choice but to foreclose on their homes because they owe more on their mortgage loan then their house is worth. Is there anyway that you can turn this tragedy around on your tax return?

Everybody is suffering... Normally, when you can't afford to pay back the money you owe the mortgage lender, the debt can be discharged. Needless to say, this has hit lenders extremely hard. Prior to 2007, any remaining money left on your debt after the foreclosure had to be reported as income on your tax return.

Help on the horizon... In 2007, the Mortgage Debt Relief Act made it possible for Americans who had lost their homes due to the sub-prime catastrophe to not have to report debt left over after a foreclosure as taxable income.

However, not everyone can get assistance for that. There are requirements to getting a cancellation of your debt income.

  • The foreclosure had to be a direct result of a decline in the home's value
  • Or the foreclosure had to happen because of a change in your financial condition
  • The house had to actually be foreclosed on. If you chose to sell the house and your profit came up short, then you still have to report the debt income as taxable


What can I do? So, do you have to owe anything to the IRS if your home is foreclosed on? Well, that depends on if after the foreclosure, you received a financial gain from the sale, or a financial loss.

Get some pen and paper... To figure out if you owe or not, here's a simplified formula for figuring gain or loss:

Fair market value of the property minus the purchase price of the property equals a gain if the number is positive or loss if the number is negative.

If you have a gain, you have to report it on your tax return as income. If there's a loss, you don't have any income to report. However, you can't use the loss as a deduction on your taxes, either.

To collect or not to collect... The IRS wants to be able to collect from you if you owe a debt to them. However, if you can't afford to pay your mortgage, it's unlikely the IRS will get any money you might owe them. The Mortgage Debt Relief Act makes it possible to not have to owe the IRS.

Now you have the smoking gun...Use it!

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