Forced Home Sale Can Result in Income to the Borrower

By Nevius, Alistair M. | Journal of Accountancy, September 2007 | Go to article overview

Forced Home Sale Can Result in Income to the Borrower


Nevius, Alistair M., Journal of Accountancy


When the real estate market was booming, many homeowners either borrowed heavily to buy in at the top or took out home-equity loans, which added to their debt. Now that the real estate market has cooled, some homeowners are waking up to an unpleasant reality: They can't make their mortgage payments, and their debt exceeds the property's fair market value. Often a foreclosure, which may be only a missed mortgage payment or two away, is the inevitable conclusion to an otherwise uncertain situation. But the homeowners not only owe money to the bank, they can also face some unexpected income tax consequences if the unpaid amount of the loan is forgiven by the lender.

Typically, lenders do not want to own real estate. They will go to great lengths not to foreclose. It is a lengthy and costly process. They are in the business of lending money, not owning real estate. A foreclosure puts a nonperforming asset on the lenders' books.

DEBT DISCHARGE INCOME

A foreclosure (or deed in lieu of foreclosure) can result in income to the borrower if the lender forgives some or all of the unpaid debt. In general, cancellation or forgiveness of a debt results in gross income--debt discharge income--for the borrower, unless an exception applies because the taxpayer declared bankruptcy or was insolvent at the time of discharge. Borrowers must report this income on their tax returns (on the "Other Income" line of Form 1040 or on Schedule C), and certain lenders (for example, banks and other financial institutions) must issue a Form 1099-A, Acquisition or Abandonment of Secured Property, to the borrower, reporting the balance of the loan and the fair market value of the property. …

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