When life doesn’t go as you had planned, and either bankruptcy or home foreclosure is necessary, what are the tax implications?
Cancelled debt is generally considered taxable income, but fortunately bankruptcy is a big exception to that rule. However, expenses accrued as the result of bankruptcy cannot be itemized and claimed as deductions either. When filing bankruptcy, there are several important tips to remember regarding taxes. It is usually best to file your taxes for the year before your file bankruptcy, if you are going to owe money. If you have already filed taxes and received a refund, do not use your tax refund to pay bills. Do keep receipts of how any refund money is spent because the information will be needed during bankruptcy proceedings.
When your home forecloses there is a possibility for taxable income in any gains that are achieved from the sale of the foreclosure or through the taxable cancellation of debt income. However, as in the case of bankruptcy, losses from foreclosures are not reportable as tax deductions.
What is the difference between a short sale and a foreclosure? Both occur when the homeowner cannot continue to make mortgage payments. In the case of a short sale, you sell the home for less than your owe on it and the mortgage company forgives the remaining balance. This differs from foreclosures which involve the mortgage lender actually taking possession of the home and canceling the entire balance due. When this happens you are liable for the taxable income on the capital gain from the foreclosure.
IRS website includes tools to calculate cancellation of debt income and gain from foreclosure. There are a high number of different scenarios possible when it comes to taxes and bankruptcy or foreclosure. If you are looking for more specific information related to your own unique situation, the IRS website also contains a publication on bankruptcies as they relate to taxes. ITP Taxes, LLC is also available to help answer your specific questions as they arise!