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Time Is Running Out For Avoiding Taxable Income On Your Foreclosure

By Donna S. Robinson | March 12, 2012

It seems that the ultimate "insult-to-injury" scenario would be to lose your personal residence to foreclosure or a short sale, then find out that you owe taxes on the "income" you "received" as a result. But that is exactly what could happen to millions of homeowners who will face foreclosure or be forced into a short sale on their personal home after December 31, 2012. That's when the current "Mortgage Forgiveness Debt Relief Act" expires.

Tax nightmare on its way... © Bobb Klissourski -

Given that various sources such as the Federal Reserve and housing market analysts have stated in recent months that we could see as many as 8 MILLION new foreclosures over the next 6 years or so, we can only hope that the U.S. Government will consider extending this act for several years longer. But if they don't, and you are worried about foreclosure or a short sale, perhaps you'd better make plans to get it over with before 2012 ends. Short sales can easily take 6 months or longer to complete so you are running out of time.

Short sales are much more frequent today than they were prior to the housing crisis. When a home owner is in eminent danger of foreclosure, he or she may elect to put their home on the market with a real estate agent, and attempt to sell the home for whatever price it will bring. If the seller owes $150,000 on their home, and the only buyer they can find is willing to only pay $100,000 for the home, the seller could sell for less than they owe to avoid having a foreclosure on their credit. But once the debt relief act expires, that $50,000 difference could end up being taxable to the seller as regular income.

The same holds true for the foreclosure also. You could be foreclosed on, and still owe taxes on the amount of debt that was "forgiven". And in the case of short sales, a lender will likely take months to approve the short sale, so the 9.7 months remaining in 2012 are not much time when it comes to starting and completing one.

The debt relief act was originally passed to cover the period from 2007 to 2012. At the time it was finalized, in early 2008, no one expected that the housing market would still be looking at millions of additional foreclosures going well beyond 2012, and by some accounts, expected to drag on for up to 6 more years. If the act does expire on December 31st of this year, it will leave millions of homeowners facing the possibility of owing thousands of dollars in additional income taxes.

There are also rules that determine how much of the debt is taxable. This relief has only been extended to personal residences, and does not apply to second homes or investment property. But once expired, even personal residences will be included. Check with your accountant or read the details of the act in the link in this article, to see how you might be affected. Pass this along to friends who may be in danger of foreclosure. This could be a nasty surprise for millions of home owners if the act is not extended.

One can only hope that the government will realize that the foreclosure problem could drag on for years to come, and extend this act for at least 5 more years. But at present there are no known plans to do so. If you are 2 to 3 months delinquent right now, you may want to think about going ahead with plans to get a short sale approved with your lender, if you think a foreclosure may be inevitable. Time is running out.

And as a side note, I'd just like to know who came up with the idea that losing a home, a business or even a car due to economic hardship could be justified as taxable income? If it's that "profitable" to lose your home to foreclosure, maybe we should all try it.
Donna S. Robinson is a 16 year veteran of the real estate industry.  Her book, "Fundamentals & Strategies For Buying & Selling Homes" is available on her website at 

Donna S. Robinson has been involved in the real estate industry since 1996. A licensed agent and real estate investor, she is a recognized expert on residential real estate investing. Her course, "Fundamentals & Strategies For Real Estate Investing" is approved for CE credit by the GA Real Estate Commission. She has authored several books on real estate investing, and consults with residential investment companies. She also offers coaching services to real estate investors.

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