If you lose your house in foreclosure, there may be some tax consequences. If you were personally liable for the debt, you must report a sale for the lesser of the debt outstanding or the fair market value (FMV) on the date of foreclosure. If you were not personally liable, the sales price equals the debt outstanding. Up to $250,000 ($500,000 on a joint return) of any gain on the sale may be excluded if you owned and used the home as your principal residence for at least two out of five years ending on the date of the foreclosure. Any loss on the sale is a nondeductible personal loss.
You may also have cancellation of debt income if you were personally liable for the debt, the debt outstanding exceeded the FMV, and the excess debt was canceled. In general, cancellation of debt income is taxable. However, you can exclude it from gross income if it was qualified principal residence indebtedness, to the extent you were insolvent, or due to bankruptcy.
Qualified principal residence indebtedness is debt incurred to acquire, construct, or substantially improve your principal residence. If you took out a home equity loan to pay off credit card debt, that part of the loan does not qualify for the exclusion. In this case, the amount that may be excluded from income is limited to the amount canceled over the amount that is not qualified principal residence indebtedness. The balance of the debt, however, may still qualify for the insolvency or bankruptcy exception.
Posted on 2010-09-07 19:27:14