The sale of any property and foreclosure is treated the same way by Uncle Sam. Since the property was transferred to another person, there could be taxes on such a property. This is because of the capital gain that the process triggers, and the person could incur income taxes on any part of the mortgage debt, which could have been canceled.
Capital Gains on Foreclosures
The process of selling property happens via an escrow process. The seller will get a statement revealing the selling price of the house. However, foreclosures do not come with an escrow process as the lending bank simply seizes the possession.
Uncle Sam classified a foreclosure as a sale and a property disposition in technical terms – since the property has changed hands.
To calculate capital gains, one needs to subtract the property cost or basis from the sales price. The difference gives the profit of the seller or the loss.
Most of the time, a foreclosure situation does not involve an agreed sales price, although it does come with a sales price for tax purposes. This can either be any of the following:
The loan balance outstanding before the foreclosure
The fair market property value on the foreclosure date
This many times depends on the mortgage – whether it was a nonrecourse or recourse loan.
Recourse Loans
Having a recourse loan means one is personally liable for the mortgage debt. This means that after the repossession of the property, the lender goes for repayment. For cases like this, the sales price figure in estimating the potential gain is the lower of any of the two:
The loan balance outstanding just before the foreclosure without the debt in which the borrower is liable after the process of foreclosure
The property’s fair market value
This loan type can bring about the cancellation of income debt from foreclosure, alongside the capital gain.
Nonrecourse loans are the mortgage used to acquire homes, even though home equity loans and refinanced homes are recourse loans. This is not an absolute law because it is usually a factor of the laws of the state where you live.
Nonrecourse Loans
With a nonrecourse loan, the borrower is not liable for the loan repayment. The property's repossession satisfies the loan, which stops the lender from requesting further payment from the borrower.
The sales price figure here is the loan balance that is outstanding just before the foreclosure. Uncle Sam believes that the sale of the house is to the lender, which considers the exceptional debt; hence there is no capital gain.
The non-recourse loan comes with no canceled debt income because the law forbids the lender from coming after you for repayment.
Important Tax Reporting Documents one will get
After a foreclosure, one will typically get either one or both of the following:
Form 1099-A: the bank issues this upon the foreclosure of the real estate. With this form, you get the foreclosure date, the property’s fair market value. This information is essential for reporting the capital gains on the property.
Form 1099-C: the bank issues form 1099-C after it cancels or forgives a debt that is on the recourse loan. The form reveals the value of the canceled debt. You might get a single 1099-C form that indicates the debt cancellation and the foreclosure, or one might call a 1099-A and a 1099-C assuming the lender forecloses the home and gets rid of the debt in the same tax year.
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