tax implications of a deed in lieu of foreclosure
There is no myth as wrong as the one that says you will owe a lot in taxes if you do a deed in lieu of foreclosure. People are often incorrect in what they believe about the tax implications of a deed in lieu of foreclosure. They spend sleepless nights worrying about a 1099 from their bank.
But actually, you may not owe any taxes to the IRS if you lose your house in foreclosure or a deed in lieu of foreclosure.
First of all, this type of income is known as debt cancellation income. A mortgage loan is not income because you have to pay it back. But if the debt is forgiven and you've already received it, then that portion that is forgiven is known as debt cancellation income. Normally income tax is due on that amount of debt that is forgiven.
But you don't necessarily owe any money to the IRS.
The IRS has this to say about the matter:
- Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you.You are insolvent when your total debts are more than the fair market value of your total assets.Insolvency can be fairly complex to determine and the assistance of a tax professional is recommended if you believe you qualify for this exception.
- Non-recourse loans:A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral.That is, the lender cannot pursue you personally in case of default.Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income.However, it may result in other tax consequences, as discussed in Question 3 below.
In plain English, most of us have a significant amount of our net worth tied up in our house. If our house is under water, that is, if we owe a lot more on our house than it's worth, then chances are we are technically insolvent according to the IRS. And so if we lose our house in foreclosure or in deed in lieu of foreclosure, we do not have to concern ourselves with a tax bill from the IRS.
I hope this sets your mind to rest. You should talk to your qualified tax advisor and never listen to an opinion from some guy on the Internet like me
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