Posted by Carmen Garcia

Tax Implications of Repossessions

Tax Implications of Repossessions

The IRS deals with foreclosure as well as the sale of a property. It was already yours, and you no longer own it, so you could end up paying taxes on a mortgaged property. The event could trigger a capital gain, and, in some cases, income tax could be owed on any portion of the mortgage debt that could have been canceled or forgiven.


Capital gains on foreclosures

The sale of real estate usually goes through a custody process. The seller receives statements indicating how much he has sold the house. However, there is no escrow period for foreclosure. The lending bank takes possession of the house.

The Internal Revenue Service says that a foreclosure is still considered a sale or, in more technical terms, a "disposition of property" because it has changed hands.

The basic formula for computing capital gains is subtracting the base or cost of ownership from the sale price. The difference is the profit made by the seller or the amount of money lost in the transaction.

There is no mutually agreed sell price in a foreclosure situation or a warranty statement, but there is always a "sale price" for tax purposes. This will be the property's fair market value on the closing date or the remaining loan balance immediately before closing. It depends if your mortgage was a loan with or without repayment.

The lender will report these amounts to you and the IRS in box 2 (outstanding loan balance) or box 4 (fair market value) of Form 1099-A.


Recourse loans

You are personally responsible for the mortgage debt if you have a recourse loan. The lender can track you for payment even after the property has been repossessed; it has recourse.

In this case, the value used as the selling price in calculating any potential capital gain is the lower of the following two values:

  • The fair market value of the foreclosed property.

  • The outstanding balance before the foreclosure minus any debt for which the borrower remains personally responsible after the foreclosure 

You can also have the foreclosure debt income set aside for this type of loan, as well as a capital gain.

Mortgages used to purchase a home are usually non-recourse loans, while refinanced loans and equity loans are usually repayable loans. However, this is not an out-and-out rule. It may also depend on the laws of the state in which you live.


Non-recourse loans

A non-recourse loan is a loan in which the borrower is not personally responsible for repaying the loan. The loan is considered satisfied, and the lender cannot request additional repayment from the borrower if the property is repossessed.

The amount used as the sale price, in this case, is the outstanding credit balance immediately before foreclosure. The IRS considers that it is selling the lender's house for full consideration of the outstanding debt, so there is usually no capital gain.

You also won't have debt income repaid with a non-recourse loan because the law prohibits the lender from suing you for repayment.


Tax Reporting Documents

You will receive one of two tax forms after foreclosure, or maybe both:

  • The bank issues Form 1099-A after the foreclosure of the asset. This Form shows the date of foreclosure, the fair market value of the property, and the outstanding loan balance immediately before foreclosure. You will need this information to report capital gains on the property.

  • The bank issues Form 1099-C after the bank has written off or canceled a recourse loan debt. This Form will show how much debt has been written off. You may receive a Form 1099-C that reports the performance and cancellation of debts, or you may receive a 1099-A and 1099-C only if the lender executes the mortgage and clears the outstanding debt.


Report a capital gain

You can determine the selling price after determining the type of loan you have on your property. Report the foreclosure on Schedule D and Form 8949 if the mortgaged property was your primary residence. You may be eligible to exclude $ 250,000 or even $ 500,000 from tax revenue under certain rules:

  • The home was your primary residence.

  • You have lived in your home for at least two of the past five years until the date of the execution.

  • You have owned the home for at least two of the past five years until the date of sale.

Individual applicants can exclude capital gains of up to $ 250,000, and jointly married applicants can double that amount.

You can still benefit from an exemption from capital gains tax under the amended rules for calculating your profit if the mortgaged property is for mixed-use: it was once your main residence and another secondary residence at another time. The rules are also relaxed a bit for members of the military.


Capital gains tax rate

As of fiscal 2020, the tax return you will file in 2021, the long-term capital gains rate for properties one year or older depends on your general taxable income and marital status.

Single Filers

  • 0% if taxable income is less than $ 40,000

  • 15% if the taxable income is between $ 40,001 and $441,450 

  • 20% if taxable income is greater than $ 441,450 

Heads of Households

  • 0% if taxable income is less than $53,600 

  • 15% if the taxable income is between $53,601 USD and $469,050 

  • 20% if taxable income is greater than $469,050 

Married Filing Jointly and Qualifying Widow(er)s

  • 0% if taxable income is less than $ 80,000

  • 15% if taxable income is between $ 80,001 and $ 496,600

  • 20% if taxable income is greater than 496,600 

These parameters of long-term capital gain are different from those in force before 2018. The rates were linked to the usual income tax brackets before TCJA. TCJA granted long-term tranches of capital gains.

This is a short-term capital gain if you've owned your home for less than a year. You have to pay capital gains tax at the same rate as your normal income, i.e., according to your tax group.


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Carmen Garcia
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