Foreclosures Lead to Tax Traps

As we all know by watching the news, the real estate market is pulling back hard from the days of glory earlier this decade. In fact, many people are losing their homes to foreclosure. Few realize the tax consequences of losing one's home.

The Internal Revenue Service looks at things in a strange manner. What you may see as a loss, it sees as a gain. The agency takes the view that any loss that relieves you of a financial obligation is actually a gain. Let's look at an example.

Okay, lets call it a given that I am a proud homeowner. I own a single family dwelling and owe $300,000 on the property. My hybrid loan starts adjusting and I go into default on the loan. The lender eventually gets a court order booting me out.

What a disaster. The home is gone and so is my equity in it. On top of that, my credit is now officially a disaster area, which effects my other credit obligations. Can you imagine a worse situation? Yes! The IRS is coming.

The IRS is very interested in that $200,000 mortgage debt. Why? How could I possibly get into tax trouble since it is a debt? Well, the agency takes the view that the relief from that debt can actually be considered income to me.

This is why people hate taxes. By going through the foreclosure, I have more or less been wiped out financially. The IRS does not care. It considers the $400,000 mortgage I escaped as income and it wants me to pay taxes on it.

As foreclosures increase, more and more people are getting very surprising letters from the IRS. It isn't bad enough that you have lost your home, you now have a monstrous tax bill. This also applies to situations where a short sale is undertaken.

Do you have any way to fight off the IRS? Yep. You need to get a written valuation of your home before getting booted. Tax in this stuation is figured on the difference between what you owe and the objective price of the property.

Attorneys and accountants are also having some succes with certain arguments. The IRS has proven receptive to the idea that the taxpayer is insolvent and can't meet the tax obligation. In such cases, the agency will terminate the tax due.

If all else fails, there is always the bankruptcy route. Although taxes generally are not terminated through bankruptcy, the "gain" you are perceived to have received is. Since there is no gain, there can be no tax and you are off the hook.

Going into foreclosure is bad enough from the straightforward perspective of losing your home. Throw in a large tax bill, and it is a real killer. Do your best to avoid this situation by selling that home or making arrangements to handle the debt.

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Richard Chappoe is with BusinessTaxRecovery.com - providing expert tax debt relief today from those unpaid taxes that have been following you.

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