Unsurprisingly, how you deal with foreclosures can have tax consequences. Depending on your circumstances, you may be responsible for two types of taxes: income taxes and capital gains taxes.
(Learn more about foreclosure.)
Essentially, if there’s a deficiency (a shortfall between the amount recovered by your lender and the amount you owe on your mortgage) in the course of a foreclosure or other type of sale, the amount is considered your taxable income, unless the deficiency arose from a loan used for the acquisition or improvement of your principal home. This exception is due to the Mortgage Forgiveness Debt Relief Act of 2007 and is covered in detail in our article on the tax consequences of canceled mortgage debt.
(To learn what a deficiency is and whether you'll be liable for one after foreclosure in your state, visit our Deficiency After Foreclsoure topic.)
Capital Gains Tax
If your adjusted tax basis on your house is less than the sale price of the house, you may incur a capital gains tax. For example, if you bought your house for $200,000 and it sells for $300,000, you have a $100,000 capital gain, minus the cost of any improvements you added to the property. This gain will be taxed at the capital gains tax rate, subject to your one-time exclusion ($250,000 for one person, $500,000 for a married couple). Check with a tax expert to see whether you’ll face a capital gains issue at the sale or foreclosure of your house. If you will, consult a bankruptcy lawyer for advice on how filing for bankruptcy might help.