How Short Sales and Foreclosures Affect Your Taxes

Whenever you sell a home, you need to calculate your capital gains to determine whether you owe any tax. If you engage in a short sale or your mortgage lender forecloses on your home, the Internal Revenue Service treats it just like a sale. Foreclosures and short sales may also require you to recognize ordinary income if the lender cancels any of your outstanding mortgage balance and you’re ineligible for an exclusion.

Short Sales and Foreclosures

Both short sales and foreclosures are usually the result of a borrower’s inability to continue making mortgage payments.

A short sale is where your mortgage lender allows you to sell the home for less than your outstanding loan balance and cancels your obligation to repay the remainder of the loan.

With a foreclosure, the mortgage lender will take possession of the home if it doesn’t receive scheduled mortgage payments over an extended period of time.

  • Also, in many cases, the lender cancels your outstanding mortgage balance.
  • Sometimes, this debt cancellation is taxable as ordinary income.

Tax on foreclosures

When your foreclosure includes a cancellation of debt, you only have an obligation to report it as ordinary income if you were personally liable for the entire mortgage, despite the security interest your lender takes in the home.

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