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Foreclosure: do we have to pay income tax on the whole amount?

I have a tax question. We now live in Michigan but our January 2008 foreclosure was a property in Utah. We were unable to sell it and had to let it go back to the bank. They told us that it would be auctioned and we would get a 1099 tax form for the short sale amount (their loss). They were unable to auction it off, so we got a tax form for the ENTIRE amount of the mortgage, as if this is income! On top of everything else we have been through, are we gonna have to pay tens of thousands of dollars on this? The property became a HUD home and now belongs to SOMEONE... why should we have to pay tax on the property amount as if the whole thing was our income? This is so screwed up and unfair. Plus, we had mortgage insurance, so how on earth can they say that this is our income?? The mortgage insurance is in place to pay off the bank in case of default! Please, no ignorant comments. We TRIED to save this situation but we were victims of an unfair mortgage like many others, PLUS my husband suddenly became disabled and unable to work while I was very pregnant with our 3rd child in a very dangerous pregnancy. We had to move out of state to save our family and were forbidden by the bank to rent out the property, which was worth $30,000 less at the time than what we paid for it 5 years previously. We had a pile of medical bills the size of a mortgage and had to move in with family for help with this difficult situation. So to anyone wanting to post some snarky remark about paying bills, don't. The last thing we wanted was to end up in a situation like this! If there's anybody out there who can help us with this tax question, we would appreciate the input or advice. We are having our taxes done Monday so I guess we will find out at that time, but we're extremely anxious about the situation and any information will help. Thank you. Thank you, Jss and Stephen for your helpful answers! I will print out the links you gave me to bring to the tax accountant. The cancelled amount was around $75,000. I only earned $23,000 last year (husband $0). Yes, we lived there for 5 straight years and it was our primary residence. I have high hopes that we might come out of this unscathed, or at least just a bit singed. Thank you from the bottom of my heart for the helpful and non-judgmental information. Stephen - I do not know what insolvent means but it sounds pretty serious so... yeah, we probably were/are insolvent. We didn't go through a bankruptcy though, just hell. Travelguruette, we did not refinance. When listing assets and debts... as of when? At the time of the foreclosure we had a WAY negative net worth. Today's story is a bit better. But we're talk ing about last year. I think we have a reasonable assurance here that we will find some mercy at the end of this tunnel. Thank you all so much! Marisa... you make yourself look bad when your message is spammy and self-promotional, when your network and Q & A are suspiciously "private" and YOU are set up to make money off your web site. I'm not stupid! Find other ways of advertising your scam!!!

Public Comments

1. 1. You may have to report sale on Schedule D (Form 1040). 2. Any debt canceled is your income if it was recourse liability. 3. If you lived in the house for two years and owned it for two years in last 5-years, you may be eligible to exclude gain of up to $250,000. Read: http://taxipay.blogspot.com/2008/03/profit-from-sale-of-your-home.html 4. The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt of recourse loan on their principal residence. Read about foreclosure or repossession http://taxipay.blogspot.com/2008/08/foreclosure-or-repossession-of-main.html
2. Canceled debts are considered by the IRS to be income and must be reported on your tax return.
3. 1. If you were insolvent, you may be able to avoid paying the tax. This is a special rule due to the current situation and is not normally the case. The bank does not determine whether you owe tax. The bank is required to send the form to you. You, the accountant, and the IRS determine whether or not you must include the amount on the 1099 in your income for tax purposes. 2. At most, you pay tax on the portion of the debt that the bank had to cancel or forgive in the short sale, in other words, the amount that you borrowed and did not repay. You do NOT pay tax on the entire value of the property. You pay tax only on what you borrowed (received as a loan). Although you did lose the house, it was worth less than what you originally borrowed, so you are still (from an accounting standpoint) making a profit, in that you received and expensive house and gave back a less expensive house (not your fault, but that is how the numbers are calculated).
4. The reason it is taxable is that you had use of the money and did not pay it back. The amount that is potentially taxable is the amount due on the loan minus the fair market value. If this is the first mortgage on the house then it is the acquisition loan and by law none of it would be taxable due to the Mortgage Forgiveness Act. If you refinanced the home then the rules change. You are responsible for the money financed minus the cost of the acquisition debt that was paid off when you refinanced. If this is a refi then you need to do a form 982 for insolvency. Get the 1099C and check the date. You need to do a financial statement as of the day before. If the date is 10/5/08 then you need to use 10/4/08. List all your assets and your debts. If your debts are more than your assets then you can exclude that much. For example, if you owe on 100,000 and your debts are 25,000 more than your assets then you only owe on 75,000. Your assets must include any 401k's or IRA's, etc. Your house was foreclosed on way before that date so you cannot use that as debt.