Defaulting borrowers need to take into account the potential financial and tax ramifications of foreclosure. A foreclosure does not completely absolve a borrower from his duties regarding a property. Actually, some states may give lenders the right to pursue the borrower for any losses incurred through the foreclosure process. Otherwise, the borrower may face a bigger than expected tax bill from the IRS.
Judicial and Nonjudicial
A foreclosure can be obtained via a judicial or nonjudicial process. In a nonjudicial process, the lender can commence foreclosure proceedings without court intervention, given that a”power of sale” clause exists in the mortgage or deed of trust. The”power of sale” clause says that the borrower preauthorizes the purchase of the property to pay off the loan balance in case of default.
Time Frame And Process
A foreclosure proceeding can be a expensive and lengthy process. The minimum time frame to complete a foreclosure is about half an hour. A nonjudicial foreclosure may be shorter since the borrower has already preauthorized the sale of the property in case of a defaultoption. The normal path of activity starts with three missed monthly payments followed by a”Notice to Accelerate.” This notice provides the borrower an additional 30-day interval to satisfy due payments before the lender initiates foreclosure proceedings with a”Notice of Default.” Once the Notice of Default was issued, the borrower will have two to three weeks (depending on state law) to negotiate with the lender so as to stop foreclosure. But if all else fail, the land will continue to a foreclosure sale, even where it’s going to be sold to the maximum bidder so as to satisfy some, or even all, of the loan.
Deficiency Judgment or even a 1099 Form
A lender may forgive the debt or pursue the borrower for damages through a deficiency judgment. A deficiency judgment happens if the lender hasn’t managed to recoup all of its losses (defaulted loan plus fees). For example, in the event the borrower defaults to a $100,000 mortgage and the lender sells the inherent land for $80,000 in a foreclosure sale, then the lender may still hold the borrower liable for the $20,000 shortfall. However, borrowers can negotiate with the lender for a”payment fulfilled” provision once the foreclosure was completed to avoid a deficiency judgment. If the lender fails to forgive the debt, it is going to send the borrower a 1099 Form, that will then need to be included in the borrower’s tax return records.
Cancellation of Tax and Debt Outcomes
According to the IRS, canceled debts are deemed taxable income. Since the borrower no longer has the duty to pay off the loan, he’s effectively earned additional income. Per the preceding example, if the lender has agreed to forgive the $20,000 shortfall, then the borrower must include that amount in his tax returns.
Legislation on Property Sale Gains and Exclusion Provisions
According to the IRS, if a foreclosed property has been sold at a profit, the profit incurred is deemed taxable income. However, homeowners are permitted to exclude up to $250,000 (or $500,000 if married and filing separately) of capital gains from taxable income, provided they have used the property as their main residence for at least two years.
Additional Foreclosure Tax Exemptions
Canceled debt may not always be taxable. In 2007, the Fund Forgiveness Debt Act stipulated that homeowners may exclude up to $2 million ($1 million if married and filing separately) from taxable income. This provision applies only to debt forgiven between 2007 and 2012 for properties that were used as the main residence for at least two years. The IRS has also included two provisions that allow defaulted borrowers from excluding canceled debt from taxable income. These include bankruptcy and bankruptcy. According to the IRS, debts discharged through bankruptcy aren’t taxable income. Meanwhile, taxpayers that can prove bankruptcy will not be asked to contain unsustainable debts in taxable income. Insolvency is accomplished when total liabilities exceed total assets. Forgiven non-recourse loans can also be exempt from taxable income. A non-recourse provision says that the lender cannot pursue the borrower’s personal assets beyond the pledged collateral to fulfill losses.