What Taxes Do You Owe After a Foreclosure

I live in Michigan, and I recently had my home foreclosed. The Lender purchased the home at the Sheriff Sale for the full amount owed including fees and interest.

After the Sheriff Sale was completed, and the Lender owned the house, they sold it for 1/2 the amount from the foreclosure.

My question is, do I have any tax liability (federal or state) due to this transaction?

Thanks,

As there should not be any cancelled debt from the sale, given the facts you've stated, the lender should not be issuing a 1099-C and there should not be any income tax liability.

Thank you for the quick reply. All of my research suggested that there would not be any tax liability, but I wanted to confirm with someone who understood the process better than I. Thanks again.

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Quoting ACS2569

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Thank you for the quick reply. All of my research suggested that there would not be any tax liability, but I wanted to confirm with someone who understood the process better than I. Thanks again.

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Even if the lender improperly issues a 1099-C you can still exclude the deficiency from federal taxes if the house was your primary residence for at least 2 out of the last 5 years.

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Quoting llworking

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Even if the lender improperly issues a 1099-C you can still exclude the deficiency from federal taxes if the house was your primary residence for at least 2 out of the last 5 years.

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You're confusing two different laws. The 24 out of 60 rule is for capital gains on the sale. The 1099-C is loan forgiveness. There is a qualified principal residence exclusion there as well, but it has no time limit, just that the loan was taken out to buy, build, or substantially improve your principal home and that it is secured by that home.

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Quoting flyingron

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You're confusing two different laws. The 24 out of 60 rule is for capital gains on the sale. The 1099-C is loan forgiveness. There is a qualified principal residence exclusion there as well, but it has no time limit, just that the loan was taken out to buy, build, or substantially improve your principal home and that it is secured by that home.

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You are not the first person to say that.

I have had more than one IRS instructor, during the summer seminars, use the 24 out of 60 rule in this context as well. The last one, when questioned on it, said "Do you think that the IRS is going to let you take the exclusion on a home you turned into a rental 10 years ago just because it was once your primary residence?"

I have never found much in the way of case law on that particular issue therefore I personally am going to go the more conservative route. However, I do acknowledge that there are two schools of thought.

I disagree with your instructors. Neither the IRS tax publication on foreclosures NOR the actual tax code makes any such requirement. The term principal residence is not, in fact, defined in the tax code directly at all, but there are several places where it is used. Section 121 (which covers the capital gains tax exclusion) doesn't say your "principal residence is where you lived 24/60," it says, you can exclude the gain if you used it as your principal residence for that time period. Clearly 24/60 is not the definition of principal residence given the statutory construction. The term principal residence is used elsewhere with different time limits (three years on the first time homebuyer credit) and others as in section 108 for the debt forgiveness, without any time qualification at all.

The best definition of principal residence comes from a tax court decision, Gates v. Comm'r of Internal Revenue (U.S.T.C., 2010).
Pretty much it says since the statute fails to define it, the ordinary meaning of the words takes precedence. They further go on to determine the meaning of both residence and principal. Further they go back over a number of other decisions of principal residence determination. NONE OF WHICH SAYS ANYTHING ABOUT 24/60.

I do agree with your instructor that you can't forgive the debt on a rental property, but NOT for the reason he gives. Section 108 says that you can forgive the debt on your principal residence. Once you turned it in to a rental property, it is no longer a principal residence and section 108 doesn't give you a 24/60 window to apply.

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Quoting flyingron

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I disagree with your instructors. Neither the IRS tax publication on foreclosures NOR the actual tax code makes any such requirement. The term principal residence is not, in fact, defined in the tax code directly at all, but there are several places where it is used. Section 121 (which covers the capital gains tax exclusion) doesn't say your "principal residence is where you lived 24/60," it says, you can exclude the gain if you used it as your principal residence for that time period. Clearly 24/60 is not the definition of principal residence given the statutory construction. The term principal residence is used elsewhere with different time limits (three years on the first time homebuyer credit) and others as in section 108 for the debt forgiveness, without any time qualification at all.

The best definition of principal residence comes from a tax court decision, Gates v. Comm'r of Internal Revenue (U.S.T.C., 2010).
Pretty much it says since the statute fails to define it, the ordinary meaning of the words takes precedence. They further go on to determine the meaning of both residence and principal. Further they go back over a number of other decisions of principal residence determination. NONE OF WHICH SAYS ANYTHING ABOUT 24/60.

I do agree with your instructor that you can't forgive the debt on a rental property, but NOT for the reason he gives. Section 108 says that you can forgive the debt on your principal residence. Once you turned it in to a rental property, it is no longer a principal residence and section 108 doesn't give you a 24/60 window to apply.

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Ok, but now you have just contradicted yourself. Previously you said "no time limit".

So, if you do not convert it's use but you move somewhere else (for a multitude of potential reasons) but it doesn't sell for 2 years and eventually forecloses, then by your definition it was not your principal residence at the time of foreclosure and therefore it should not be eligible.

I am not trying to be argumentative, I am simply pointing out that there is more than one school of thought on this issue and while lots of people have theories its simply not as clear cut as anyone would like it to be.

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Quoting llworking

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Ok, but now you have just contradicted yourself. Previously you said "no time limit".

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I still say no time limit. I could buy a house today, have it foreclosed at the end of the year, and still take the exemption.

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So, if you do not convert it's use but you move somewhere else (for a multitude of potential reasons) but it doesn't sell for 2 years and eventually forecloses, then by your definition it was not your principal residence at the time of foreclosure and therefore it should not be eligible.

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Yep, you're screwed on the the principal residence rule in that case. You'd have to use the insolvency provision.

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I am not trying to be argumentative, I am simply pointing out that there is more than one school of thought on this issue and while lots of people have theories its simply not as clear cut as anyone would like it to be.

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My school of thought is the law means what it says as written and to follow the guidance of the tax court precedent rather than inventing "law" that does not exist.

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Quoting flyingron

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I still say no time limit. I could buy a house today, have it foreclosed at the end of the year, and still take the exemption.

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Ok, I see your point on that one.

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Yep, you're screwed on the the principal residence rule in that case. You'd have to use the insolvency provision.

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So, are you saying that if someone moves out before a foreclosure is final, and establishes a new residence, that its no longer excludable? Are you saying that someone must stay there until the bitter end, rather then getting out gracefully, before its excludable?

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My school of thought is the law means what it says as written and to follow the guidance of the tax court precedent rather than inventing "law" that does not exist.

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I just read the Gates case that you cited and it has to do with capital gains and primary residence, NOT the Mortgage Debt Relief Act.