I used to think that when you couldn't pay your mortgage and went through foreclosure, all debts related to that mortgage would disappear. But after reading an article on realtor.com today, I learned something new and wanted to share it with you all.
First of all, I assume everyone knows about foreclosure, right? When a homeowner can't afford their mortgage loan, the bank seizes the property, sells it, and covers its losses—a process known as foreclosure.
So, when you go through foreclosure, it's natural to think that the debt with the bank is settled.
However, what about the IRS? It turns out they have a say in this too. They impose taxes on this part. In other words, the amount of the mortgage canceled through foreclosure is considered income, and taxes are levied on it. Typically, when you go through foreclosure, you receive a 1099-C (Cancellation of Debt) from the bank that held the loan. The amount of debt canceled is considered income.
However, there are cases where you don't have to pay this tax.
Mortgage Debt Relief Act
During the peak of the subprime mortgage crisis, the government passed the Mortgage Debt Relief Act, which prevented taxes from being levied on canceled mortgages considered as income through foreclosure. Originally, this law was only valid until 2020, but it has been extended until 2025.
To benefit from this Mortgage Debt Relief, you must meet the following two conditions:
The property must be your principal residence, meaning it's your primary place of residence.
The canceled debt amount must not exceed $750,000.
If the property going through foreclosure is not your primary residence, there's still a way to avoid taxes. Instead of just going through foreclosure, you can file for bankruptcy. This way, you can be exempt from taxes on the canceled debt.
As you may know, I'm a realtor, not a CPA. Therefore, the information I provided today may be very basic. If you have any further questions about real estate taxes, I strongly recommend consulting with a CPA or accountant, who are the experts in this field.
I'll make sure to come back with more helpful posts next time.
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