The “foreclosure tax”

Uncle Sam’s hand

If you are forced to sell your home at a loss, unlike with other investments, the losses are not tax-deductible.

Worse, if you get foreclosed and the bank sells the home for less than what you paid for it, the IRS considers the difference to be taxable income. Yup, if you bought a house for $300,000, and the bank foreclosed, selling it for $250,000, the IRS will send you a form 1099c saying you owe on $50,000 of income. Which seems monumentally unfair to me.

  • DJ

    In general, your primary residence is treated as personal-use property. Much like your car, if you sell it at a loss, that’s not a tax deduction. The difference between this and other “investments” is that an investment is first and foremost an effort to make money. Even though a primary residence is the largest investment people have, and they may indeed make money on it in the long run, its primary purpose is (by definition) to provide housing for the taxpayer.

    BTW, unlike almost any other kind of property, personal or investment, if you sell your primary residence at a gain, the first $500,000 of gain may be tax free (if certain conditions are met). You won’t get that treatment for stocks, stamps, vacant land, or even second residences.

    As for Cancellation of Debt (COD) income, it applies to the cancellation of any debt, not just mortgages. But what you’re missing is that the COD amount isn’t taxable to the extent the taxpayer was insolvent at the time the debt was forgiven. (Sec. 108(a)(1) of the Tax Code)

    BTW, there are ways to make a loss on your home deductible, but they take planning. The property must be purchased as an investment– meaning you buy it with the intention of holding it for a profit and don’t live in it for the first year (since it can’t be an investment while it’s a “qualfied residence”). If you later move in to it, it becomes a “qualified residence” for the duration of your stay, but you’ve established investment intent. Assuming you move out again (returning the property to investment status), your losses may then be deductible.

    But remember, as with any loss, you only get to deduct $3,000 a year anyway. So your $50,000 loss would get deducted over 17 years (unless you have other gains to offset).

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