A foreclosure tax bill?

Dear Tax Talk,
Due to my total disability and severe decrease in income, I lost my home last year to foreclosure. I had taken a consolidation loan on this house in the past. Now I received a Form 1099 in the total amount that I had borrowed. I used a large part of the money to pay off the original mortgage on the house. Do I have to pay taxes on the entire amount on the 1099? -- Sherry

Dear Sherry,
Following a bad year, the last thing you need is a tax nightmare.

Since your home was foreclosed on, you're treated as having sold your home. If you occupied the home as your main home for two of the last five years, you probably don't owe any tax.

If you owned the home for less than that time, you also probably don't owe any tax as a result of unforeseen circumstances.

If your home was foreclosed on or repossessed, you have a sale. You figure the gain or loss from the sale in generally the same way as gain or loss from any sale. If the value of the home was more than the canceled debt, then you compare the amount of canceled debt to your original cost for the home to figure any gain. Assuming this is less than the $250,000 in gain you're allowed to exclude, you won't have tax on the foreclosure.

If you were personally liable for the canceled debt, you may have ordinary income in addition to any gain or loss. If the canceled debt is more than the home's fair market value, you have ordinary income equal to the difference.

However, the income from cancellation of debt is not taxed to you if you are insolvent or bankrupt. Insolvent means that your debts exceed your assets. For example, if you owe $10,000 as a result of the foreclosure and other debts and have nothing but your personal possessions, you would be considered insolvent. You would not owe tax as a result of the mortgage exceeding the value of the home.