Foreclosure Tax Implications of Recourse and Non-Recourse Loans
We work very hard to purchase a home, and it can be very frustrating to be facing a foreclosure.
While every case is different, there are a few basic principles that lead toward the tax implications.
If your mortgage is a non-recourse loan then your tax ramifications
are a bit better than otherwise.
If the loan is foreclosed, then from your perspective on a tax basis the transaction is considered
to be a sale of the residence for the amount of the loan.
The ramifications of this is twofold:
- There will be no cancelation of debt income.
- A sale at the full amount of the loan could mean capital gains.
If your mortgage is a recourse loan then your tax ramifications
are very different.
In this case if the loan is foreclosed on, then it is as if you sold the house for the fair market value.
Any potential capital gains is based on that sales value.
But the difference between the fair market value of the house and the outstanding loan value is
considered cancelation of debt income. This income is taxable as ordinary income, just like wages.
So the tax will be at your marginal tax rate.
This could potentially be very serious. Consider if your house is foreclosed on with the following:
- the loan was recourse,
- the fair market value of the house is $100,000 less than the mortgage.
Then not only have you
lost your house, but the bank can either go after other assets to recover a portion of the $100,000,
or if they cancel the debt you just picked up an extra $100,000 of income. If you are in the 25%
tax bracket for federal income taxes, and 9% for California income taxes, then your tax liability
just increased by $34,000.
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