TurboTax / Tax Calculators & Tips / All Tax Guides / Home Ownership / Tax Tips for Foreclosures

Tax Tips for Foreclosures

Updated for Tax Year 2015


OVERVIEW

Understanding the tax ramifications of the foreclosure process can help minimize the financial consequences. There are several possible outcomes of a bank foreclosure, and each will affect your taxes differently.


Losing a house in a foreclosure proceeding can be a painful and traumatic experience for the homeowner. However, understanding the tax ramifications of the foreclosure process can help minimize the financial consequences. There are several possible outcomes of a bank foreclosure, and each will affect your taxes differently.

Income from canceled debt

There are two basic ways that a lender can handle a foreclosure if the amount of the debt is more than the sale price of the house. It can cancel the remainder of the debt, or it can turn it into unsecured debt that you still owe.

If the lender cancels the debt, you may have to report the forgiven amount to the Internal Revenue Service as income in the year it is canceled. Under the Mortgage Forgiveness Debt Relief Act, signed into law in 2007, you can exclude up to $2 million in forgiven debt if it directly relates to your principal residence. The act is effective for debt forgiven until December 31, 2016. This can also apply to debt that is discharged in 2017 provided that there was a written agreement entered into in 2016.

If the canceled debt applies to a second home or business office, the act does not apply and you may have to include it in your taxable income for the year.

Interest on leftover debt

Depending on the laws in your state, a lender may choose to take any debt left after the foreclosure and sale of your house and convert it to unsecured debt that you still owe to the lender. The interest you pay on this debt is no longer directly related to a property, so it does not qualify for the mortgage interest deduction.

If it appears that your property will sell for less than the total loan, consider working out a "short sale" deal with the lender before foreclosure proceedings begin. A short sale allows you to sell your property to a third party for less than the amount you owe on the debt, with the lender's permission. You may be able to negotiate a deal with the lender so you do not have to make nondeductible interest payments after the sale.

Gain on foreclosure

If the value of your property is higher than your adjusted cost basis, you may have a taxable gain when the lender forecloses, even if it does not sell the house right away. Your adjusted cost basis consists of the price you paid for the house plus any major improvements while you have owned it.

For example, if you paid $175,000 for the house and built a $35,000 addition to it, your cost basis would be $210,000. If the value of the house is more than this calculation, you may have a taxable gain to report on your tax return. If the property is your principal residence, you can exclude the first $250,000 of gain (or $500,000 if you are married and filing jointly) for tax purposes. Consider reviewing your house expenses during the time you have owned it to identify as many improvements as possible in order to minimize the capital gain.

Loss on foreclosure sale

A loss on the foreclosure of your property occurs when the fair market value is lower than your total cost of purchase plus major improvements. For example, if your house is foreclosed upon when its value is determined to be $185,000 and your cost basis is $210,000, you will have a loss of $25,000. If you end up with a loss on the foreclosure, you cannot deduct it for tax purposes if the property was your personal residence or a second home. Consider working out a loan modification, which alters your payments or terms of the loan, or short sale to minimize nondeductible losses.

Get every deduction you deserve

TurboTax Deluxe searches more than 350 tax deductions and credits so you get your maximum refund, guaranteed.

For only $54.99*
Start for Free

Looking for more information?

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.


Security is built into everything we do
Here's how
* Important Offer Details and Disclosures
  • Filing Deadline: IRS filing deadline for tax year 2015 is April 18, 2016 (except for residents of Massachusetts or Maine, where the IRS filing deadline for tax year 2015 is April 19, 2016).
  • Try for Free/Pay When You File: TurboTax online and mobile pricing is based on your tax situation and varies by product. Free 1040EZ/A + Free State offer only available with TurboTax Federal Free Edition; Offer may change or end at any time without notice. Actual prices are determined at the time of print or e-file and are subject to change without notice. Savings and price comparisons based on anticipated price increase expected 3/18/16. Special discount offers may not be valid for mobile in-app purchases.
  • TurboTax CD/Download products: Price includes tax preparation and printing of federal tax returns and free federal e-file of up to 5 federal tax returns. Additional fees apply for efiling state returns. E-file fees do not apply to New York state returns. Savings and price comparison based on anticipated price increase expected 3/18/16. Prices subject to change without notice.
  • Anytime, anywhere: Internet access required; standard message and data rates apply to download and use mobile app.
  • Fastest refund possible: Fastest tax refund with efile and direct deposit; tax refund timeframes will vary.
  • Pay for TurboTax out of your federal refund: A $X.XX Refund Processing Service fee applies to this payment method. Prices are subject to change without notice. This benefit is available with TurboTax Federal products except the TurboTax Home & Business/QuickBooks Self-Employed bundle offers.
  • About our TurboTax Product Experts: Customer service and product support vary by time of year.
  • About our credentialed tax experts: Live tax advice service is available via phone for your toughest tax questions; fees may apply. Service, experience levels, hours of operation and availability vary, and are subject to restriction and change without notice. Not available for TurboTax Business customers.
  • #1 best-selling tax software: Based on aggregated sales data for all tax year 2014 TurboTax products.
  • Most Popular: TurboTax Deluxe is our most popular product among TurboTax Online users with more complex tax situations.