Will Your Outstanding Debt be Cancelled After Foreclosure
Foreclosure rate has increased substantially in the post-economic depression period in
the U.S. Many people look forward to cancellation of debt after they have lost their home
due to foreclosure. Cancellation of debt would indeed be beneficial for you. However,
you might have to pay taxes on the forgiven amount which can make your financial
condition even worse.
After the lender has acquired a foreclosure judgment against the debtor from the court,
he will claim his property and sell it through auction. The amount of money that is raised
will be used to clear the debt that the debtor owes on the mortgage loan. If the home is
sold then the debtor is free of the mortgage obligation. In case the bank cannot sell it
through auction, it will try out other ways such as selling through a real estate agent. In
this situation, the house will become a REO (Real Estate Owned) property. The lenders
have to pay tax on the property and they also need to sell the home as soon as possible.
Therefore, they are usually keen on selling the property. This often leads to the property
being sold at a price less than what it is worth. Sometimes the price at which the house is
sold is less than the amount which the debtor owes to the lender. This difference between
debt amount and the foreclosure price is described as mortgage deficiency.
The mortgage lenders usually have two choices when it comes to dealing with mortgage
deficiency. They can either file a lawsuit to sue the debtor or they can cancel the
debt. Some states do not allow the lenders to sue the debtors for the outstanding debt.
Therefore, in most cases the lender writes off the foreclosure debt. Moreover, filing
a lawsuit might not be always viable because sometimes the mortgage deficiency is
so huge that the chances of collecting the debt are practically negligible. If the debtor
is jobless or underemployed then the possibility of recovery is all the more reduced.
Nonetheless, this loss will result in tax benefits for the lender.
If the debt is cancelled by the lender then he will write it off as tax loss. When the year
ends, the lender will mail form 1099 (which contains the details of the forgiven debt)
to the debtor. The borrower might have to pay quite a huge amount of tax due to this
because the amount forgiven is perceived as income by the tax bureau.
The mortgage forgiveness debt relief act allows people to avoid the tax charges on the
forgiven foreclosure debt. However, there are some clauses. You will be eligible for tax
forgiveness only if you been forgiven less than $1 million ($2 million in case you are
married) and have lost your main dwelling place (and not your investment or vacation
properties). To avoid tax consequences you also need to fill form 982.
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