Mortgage Foreclosure Tax Issues

Numerous factors have contributed to the current problems in the mortgage and housing industries.  In large part, many of the problems stem from home buyers, mortgage companies and investors making bad decisions and either not understanding clearly or misusing some of the new and valuable financial innovations that have become available in recent years. Consequently, credit and housing markets are going through a period of painful adjustment, with the result that some homeowners will face foreclosure. 

Foreclosure can result in unexpected tax consequences to the debtor, with the precise impact depending on the type of debt involved, state law, and whether the foreclosure is structured as a “short sale.”  In addition, mortgage foreclosure can have tax consequences to the lender.   

On Sept. 17, IRS issued a news release announcing that it has added a frequently asked questions (FAQ’s) section on its website devoted to tax issues facing taxpayers who lose their homes due to foreclosure. In the news release, IRS also reassured homeowners that while mortgage workouts and foreclosures can have tax consequences, special relief provisions exist to “reduce or eliminate the tax bite for financially strapped taxpayers who lose their homes.”  In addition, there may be viable alternatives to foreclosure that don’t carry the same negative tax consequences.

The current problems in the credit and housing markets have also caught the attention of the Congress and the Administration.  Legislation has been proposed that would alter the tax consequences of mortgage foreclosure.