Losing a home to foreclosure can be one of the most difficult experiences any family will undergo. Not only does the family have to find a new place to live, a process which can be costly, but the family’s options may be severely limited by the damage done to the homeowners’ credit ratings as a result of the foreclosure process. It would seem like the government would do as much as possible to help homeowners who have recently gone through the foreclosure process, but it took an act of Congress to stop a U.S. tax law which would have forced people to pay taxes on their losses.
In general, U.S. tax law stipulates that a person who defaults on a loan may be responsible for paying taxes on the portion of that loan which went unpaid. For example, if a homeowner purchases a home for $200,000, pays the loan down to $180,000, and then goes into foreclosure, the home will be sold at auction. If the home in the above example sells for $150,000, this means that the homeowner is only credited with having repaid $150,000 of the $180,000 he or she owed. The $30,000 difference is considered “cancelled debt” by IRS, and may be subject to taxation.
In 2007 the U.S. Congress enacted the Mortgage Forgiveness Tax Relief Act which was meant to help homeowners who had had debt canceled as a result of foreclosure on a primary residence. The act, which was extended several times through December 31, 2013, allowed homeowners to avoid paying taxes on this canceled debt. Generally speaking, those who went through foreclosure, or sold their home in a short sale, within this time period were able to avoid paying taxes. But, those who lost their homes to foreclosure or completed a short sale after December 31, 2013 may have tax liabilities as a result.
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