By Elisa Shoenberger, 
While the rate of foreclosures has definitely slowed down since the height of the crisis in 2010, foreclosures are still widespread across the US. Attom Data Solutions reported that in the first half of 2019, about 300,000 foreclosures were filed, a decrease of 18 percent from 2018.
What Happens to Tenants in Foreclosed Rental Properties?
However, the report notes that there has been an increase in foreclosures in certain markets: “Six of the 220 metropolitan statistical areas analyzed in the report (16 percent) posted a year-over-year increase in foreclosure activity in the first six months of 2019, including Buffalo, New York (up 33 percent); Orlando, Florida (up 32 percent); Jacksonville, Florida (up 18 percent); Miami, Florida (up 7 percent); and Tampa-St. Petersburg, Florida (up 5 percent).”
While dealing with foreclosures can be a frustrating process in itself, homeowners have to contend with possible tax liabilities related to their foreclosure. Here is some basic information to help homeowners navigate the tricky field of foreclosure and taxes.
What is foreclosure?
Foreclosure is defined as “a catch-all term for the processes used by mortgage-holders, or mortgagees, to take mortgaged property from borrowers who default on their mortgages.” U.S. Department of Housing and Urban Development notes, however, “in general, mortgage companies start foreclosure processes about 3 to 6 months after the first missed mortgage payment. Late fees are charged after 10 to 15 days; however, most mortgage companies recognize that homeowners may be facing short-term financial hardships.” Foreclosure laws vary by state.
In foreclosure, owners may have options including loan reinstatement, forbearance, short sale, and more depending on their circumstances. A short sale is one option in lieu of foreclosure, explains McCarthy Law PLC because “many borrowers see a short sale as a more appealing alternative to foreclosure because it is not on public record, may have a less significant effect on future employment, and maybe less restrictive on your ability to get loans in the future.” The difference between the sale price and the original mortgage is considered loan forgiveness.
Foreclosed properties, on the other hand, also may result in loan forgiveness. Attorney Mark J. Kohler of Mark J. Kohler notes: “The mortgage holder forecloses on the property, takes possession, or sells the property on the courthouse steps and will probably end up losing on the original mortgage. In effect, the borrower usually doesn’t have to pay the full mortgage, and whatever the lender can get for the property reduces the mortgage amount and the lender will often take a loss on the rest."
How could my loan forgiveness impact my income taxes?
Yes, if a property is sold at a short sale or in foreclosure at less than the amount of the loan, there is possibly a tax liability. “Although the borrower is not receiving cash, the IRS considers the extinguished debt obligation to be taxable income,” explains Koontz & Associates, PL. Koontz continues to explain: “It is important to understand the reason that forgiven debt is treated as income. At the time the loan was made, the loan proceeds were not included in the taxable income of the borrower because there was an obligation to repay the loan. However, when the debt is forgiven, the obligation to repay the loan goes away, and taxable income is triggered.”
What about the Mortgage Debt Forgiveness Relief Act?
During the Foreclosure crisis, Congress passed the Mortgage Debt Forgiveness Relief Act (The Act) in 2007. Koontz explains, “the Act offers relief to borrowers by excluding some or all of the forgiven debt from taxable income, subject to certain conditions.” Conditions included that the residence/property was the borrower’s principal residence, and the money was used to purchase, improve, construct the property and only apply to the first $2 million.
However, the Act had to be extended several times by Congress. There was a 2019 bill to extend the Act through 2020. Ken Barry, J.D., of CPA Practice Advisor, reported in December 2019 that Congress extended some legislation through 2020 and that the president was expected to sign it, including mortgage debt forgiveness. However, the IRS website on Home Foreclosure and Debt Relief dated September 2019 reports that “this provision applies to debt forgiven in calendar years 2007 through 2017.” It may be worth consulting your accountant or an attorney to determine whether you are eligible.
What is considered my principal residence?
Koontz notes that people often conflate principal residence and homestead, particularly in Florida. “A Florida homeowner has the ability to designate their newly purchased property as their homestead as soon as they begin to occupy the property as their main home, whereas property may only be considered a principal residence if the residence has been owned and occupied by the homeowner as their main home for at least two of the last five years immediately preceding the date the debt is forgiven,” Koontz writes, “in the context of a short sale, the date the debt is released may or may not be the date of closing as, in some instances, the deficiency is negotiated after completion of the short sale.”
When should I consult an attorney?
When dealing with tax liabilities and foreclosures, it may be best to talk to an attorney or an accountant to figure out your own specific situation and whether the Act is applicable to your situation. States have different foreclosure laws, which may also impact your specific situation.
