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Special section Fighting foreclosure

Losing your home in a foreclosure is bad enough. Wait until you get the tax bill.

Double whammy: Foreclosure and taxes

Double whammy: Foreclosure and taxes
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One thing lending and tax experts all agree on: If you're facing foreclosure, take action as soon as you realize you're in trouble. And get professional help to determine exactly what your personal tax liability might be in the transaction.

Lanzaro has two other recommendations: "The best advice is, don't buy a house you can't afford and don't get an adjustable-rate mortgage."

Other options
If you're stuck with more house than you can pay for, there are a couple of options in addition to foreclosure. Either is likely to reduce the stress of this terrible time and probably will do a little less damage to your credit report.

Each, however, still has tax and other potential long-term financial implications.

Short sale: This real-estate transaction has become popular among homeowners who are having problems making payments on a mortgage that is more than their house is worth. Rather than waiting for the bank to foreclose, the owner works with the lender to complete a sale of the home for less than the loan balance.

Foreclosure and taxes
Which mortgages get hit with the tax?
Why foreclosure is a sale
Silver lining for some foreclosures
Options other than foreclosure

"You have a property you're just trying to get out from under," says Paul Haarman, vice president of Renaissance Mortgage in Salem, N.H. "Everybody is all lined up at the table and the buyer buys the property and the lender agrees to the price. You have a $250,000 debt, the bank nets only $220,000 and that $30,000 is written as a foreclosure shortage." 

A short sale keeps a foreclosure from showing up in your credit record, but the shortfall will appear there as a delinquent loan. It's not as bad as a foreclosure, but, says Bost, "It's on the credit report and, as a (future) borrower and consumer, it will haunt you."

Deed-in-lieu of foreclosure: In this case, says Trenholm, the homeowner basically says to the lender, "I want to save you some time, some money. How about I just turn over the property?"

This way the foreclosure process is avoided, which will help the borrower, because it won't show up on a credit record. However, it could still show up on a credit report as forgiven debt.

This process has "pretty much the same tax consequences as a foreclosure," says Trenholm. Because you are being relieved of the indebtedness on the property, for tax purposes it's still considered sale of the property.

"All it does is make it a little bit easier to go through the process," he says.

Tax liabilities remain
The argument for short sales and deeds-in-lieu is that they are beneficial to strapped borrowers. From a tax and financial perspective, however, they don't really matter.

"All of these situations are basically the same," says Stein. "The mechanics and timing may be a little different, but essentially in all of them at some point a lender is saying to the borrower you don't have to pay the rest of what you owe. When he tells the borrower that, that's cancellation of indebtedness income."

"The only benefit," says Bost, "is the 'It's over' factor."

-- Updated: Oct. 25, 2007
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