Tax
Impact of Foreclosure of Principal Residence
A house foreclosure
results in the Cancellation of Indebtedness which is normally taxable
under the Internal Revenue Code. The tax
law changes in the 2007 Mortgage
Relief Act,
eliminate this incomeor most foreclosures occurring
before 2013.
The
tax relief comes in the special provision Qualified Principal
Indebtedness Exclusion, and
up to $2 million of cancellation of debt (COD) can be excluded under
this provision. To qualify for the exclusion
- the
COD transaction must occur before 2013;
- the
cancelled debt must have been originally incurred to acquire,
construct, or improve the taxpayer’s principal residence;
- and
the debt must be secured by that residence.
The
taxpayer’s basis (generally what was paid for the house plus
the costs of any improvements) in the residence is reduced, but not
below zero, by the amount excluded under this exception.
The
result is any excluded COD (Cancellation of inDebtedness
Income) will decrease any loss (or increase any gain) on the
sale of the residence. Usually this does not matter since the loss is
not deductible and any gain up to $250,000 ($500,000 if married)
generally qualifies for the home-gain exclusion, and is
therefore not taxable.
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