On September 17, the Internal Revenue Service added a new section to its website. In addition to explaining the potential tax consequences of mortgage workouts and foreclosures, the section also informs taxpayers of "special relief provisions [that] can often reduce or eliminate the tax bite for financially strapped borrowers who lose their homes."
According to the IRS news release, "The new section of IRS.gov includes a variety of information, including a worksheet designed to help borrowers determine whether any of the foreclosure-related relief provisions apply to them. For those taxpayers who find they owe additional tax, it also includes a form they can use to request a payment agreement with the IRS. In some cases eligible taxpayers may qualify to settle their tax debt for less than the full amount due using an offer-in-compromise." It kind of sounds like one of those real estate ads that names a selling price, but adds that "seller is flexible."
The presence of this addition to the IRS website is certainly a good thing, and one hopes that it will receive more notice than it has so far. It is well known that an outbreak of foreclosures is among the chief unhappy consequences of the irrational lending policies of the past few years. What is less known, especially among those who are being foreclosed upon, is that there may also be negative tax consequences to the homeowner. As the IRS site states it, "Under the tax law, if the debt wiped out through the foreclosure exceeds the value of the property, the difference is normally taxable income."
The emphasis needs to be on "normally." It is not always the case that debt relief is taxable; and this is something that the IRS site takes pains to point out. In doing so, the section addresses not only those who didn't know about the possible tax consequences of debt relief, but also it provides important information for those who might have mistakenly believed that a foreclosure would result in tax obligations for them.
The section discusses different situations when cancellation of debt does not result in taxable income. An important situation is when the debt is in the form of a non-recourse loan. "A non-recourse loan is a loan for which the lender's only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from foreclosure does not result in cancellation of debt income."
That's the good news. Unfortunately, there still may be other tax consequences when a non-recourse loan is wiped out as a result of foreclosure. That will depend on the particular situation.
A particularly helpful aspect of the new website section is that it includes worksheets and examples. Moreover, it provides links to other IRS publications that also offer worksheets and examples. There is also a link to the form 1099-C, which is the form used for reporting debt cancellation. This is the form from which the IRS gets its information, and taxpayers who receive one need to know that they should verify its accuracy.
It has certainly not been the point of this discussion to summarize the information that is now available on the IRS website. Rather, it has been to make readers aware that this information is available, and that it is something that should be seen by anyone who is facing or contemplating foreclosure.
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