Blog Post

You mean I may still have to pay after a foreclosure?

Posted by: Paula Greenway
July 12, 2008
Topic: Alabama Home Foreclosure

An article titled "Lose Homes, Pay More Tax" by Jonathan Glater, published in the May 30, 2008 edition of the New York Times, described a not-so-well-known glitch in our tax laws (described in the article as a "tax bomb"). If you have a debt which is forgiven or written off by your lender, that amount (which is forgiven or written off) can be treated as taxable income by the IRS. Therefore, if you have a second home or rental property (not your primary residence) and it is foreclosed or even sold through a short sale, you will be taxed on the shortfall or deficiency to the lender. Luckily, loans made to acquire or improve primary residences are excluded from this rule for tax years 2007 through 2009.

There are two exceptions to the "tax bomb" which were not given in this article: (1) If you are insolvent (which can be hard to prove after the fact) at the time of the debt forgiveness, you will be forgiven your tax liability; and (2) If you file bankruptcy prior to the debt forgiveness (foreclosure or short sale) the bankruptcy will not only stop the foreclosure (at least for a short time), but also discharge the debt, so there's nothing to forgive and no income to tax.

Although insolvency is difficult to prove after the fact, there is no doubt about the bankruptcy exception. Many people shy away from bankruptcy but this is a misnomer. It can be a welcomed remedy when dealing with the possibility of a looming foreclosure.

Blog Post

You mean I may still have to pay after a foreclosure?

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