What About Taxes on Short Pays And Foreclosures?

In case you're involved in either one of these situations, it's important to know you may be paying the IRS some money.

A "short pay" is where you were soon going into foreclosure, or you knew you were have difficulty in keeping up with your payments, and fortunately, you were able to sell before the inevitable occurred. The bank took back your loan for less than you owed on it, because you just weren't able to sell your property for more than it sold for. So if you owed $400,000 on your loan balance and the bank agreed to settle at $380,000, the bank lost $20,000 on their loan. Or, in the situation where you did go into foreclosure and the bank still lost money on their loan because they couldn't ultimately sell the property high enough to recover their loan amount, they are still faced with a money loss situation.

In either of these events, you could face a capital gain or loss or relief of debt amount for reporting on your tax return. There are many factors involved, such as how the property was held, i.e., whether or not it was your personal residence or held for resale, and what your basis was in the property, will be important information. Whether it was "recourse" or "non-recourse" debt is significant.

The important thing to know is that your tax advisor is all important in this situation. The law requires lenders to issue a 1099, but you shouldn't assume that the amount you see is the full amount of debt that you owe taxes on. This is probably not the time to do your taxes yourself, but instead seek full advice from a competent tax advisor. More information is available from the IRS.

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