Tax Consequences of Foreclosure

The inability to pay obligations of mortgage loans may result in life-changing consequences. There are options associated with a voluntary agreement allowing relief for borrowers by lenders, such as a short sale which allows the sale of athe property for a price that is lower than the total mortgage debt. The other voluntary option is a “deed in lieu” of foreclosure. This process allows a borrower to give the property back to the lender without any further financial obligations. However, a foreclosure is the involuntary legal process initiated by the lender to repossess a defaulted property for liquidation.  Understanding the process and implications of foreclosure will be beneficial in making difficult decisions. The best defense is to play offense. If you have specific concerns regarding the consequences of a short sale vs. foreclosure, fill out this form to request a free consultation with the Law Office of Yuriy Moshes, P.C.

What Are the Consequences of a Foreclosure?

There are several consequences of foreclosure on a recourse mortgage. 

  • Tax liability
  • Derogatory mark on your consumer credit report
  • Loss of property and equity
  • Emotional stress

Consumers that foreclosed on a nonrecourse mortgage are exempt from owing anything to the lender.

Finding a new home

Foreclosure of a primary residence may trigger the daunting task of searching for a new home. This process may be difficult due to the financial and credit implications. There are limited means for a loan approval immediately. In many cases, the options are either renting or finding alternate arrangements with family or friends.

consequences of foreclosure

Suffering the credit fallout

The credit fallout from foreclosure has an adverse effect.  It is not uncommon for the credit score to drop 100 points or more resulting from the unpaid mortgage payment over a four-month period. A beginning credit score of 650 would drop below 550 and create further difficulties in securing new loans and approval for a rental property. Non-payments hold a high impact on a credit score. Foreclosures remain on a borrower’s credit report for a seven-year period as a derogatory mark. Not only does the borrower suffer a loss of property ownership but also the loss of the property’s equity.

Buying a new home

Many borrowers search for an opportunity to purchase another home after facing foreclosure. In most cases, lenders require waiting periods before considering a mortgage application. Typically, lenders require anywhere from 3 to 7 years, however, extenuating circumstances may be taken into consideration, such as:

• Loss of a job

• Medical hardship

• Business closure

Due to COVID-19, The Emergency and Foreclosure Prevention Act of 2020 allows homeowners to file a hardship declaration form with mortgage lenders through May 1st. In some instances, providing documentation that explains extenuating circumstances that allow for earlier acceptance by a lender.

There are a few options to secure a new mortgage after a foreclosure:

1. Federal Housing Administration Loan (FHA): This type of loan is most often the best option following adverse action as it required a waiting period of only three years and a credit score of 580 with 10% down.

2. A conventional loan: A typical conventional loan requires 3% down with a credit score of 620.

3. VA loan: Approval for a new loan can occur in as little as two years, however, it is only available for borrowers serving or veterans of the military.

4. Non-QM loan: This loan is not backed by the government, as it does not meet the requirements. It is possible to obtain this type of loan quickly after a foreclosure but often requires higher fees, interest rates, and other qualifications.

5. United States Department of Agriculture (USDA) loan: A USDA loan is backed by the government to promote home buying in rural and low-income areas. Typically, a credit score of 640 is required for approval following a 3-year waiting period.

Owing an Employer an Explanation

There are legal consequences for a foreclosure. Since it is classified as a civil procedure it becomes a public record in the county where the action was filed and will appear on a credit check, as it adversely affects the borrower’s consumer credit history. It will appear, however, on a credit check. Employers that require a credit check for employment will have access to this information. It is not a criminal matter so it will not appear on a criminal history report.

Getting hit with a surprise tax bill

Once the courts grant the lender a foreclosure on the default mortgage, the lender is legally allowed to sell the property. Under normal circumstances, an escrow process occurs providing the seller information regarding the amount the property sold for, but this does not occur in a foreclosure. The property is sold at a public auction, followed by the eviction of the defaulting party from the property.

The property transfer is treated just like a regular property sale, yet there may still be debt that is not erased from the transaction. A foreclosure that occurs within two years of property ownership may result in a capital gains tax, meaning that if the total debt prior to the filing is $300,000 and the value of the property, according to the market is $275,000, the $25,000 may be considered income by the IRS for the borrower once the property is sold. The same tax consequences may apply to a deed in lieu of foreclosure.

Living through loss

Emotional and psychological consequences resulting from a foreclosure can result in depression and anxiety. Financial constraints and instability compound these issues. It is important to know the facts and options. Be prepared for outsiders to offer opinions but remember this situation is temporary. Focus on moving forward and what steps to take in securing yourself and not blaming yourself. If you have concerns regarding a foreclosure, request your free consultation by filling out this form.

Tax Consequences of Foreclosure of Investment Property

The tax consequences of foreclosure of investment property may be different from a primary residence. Normally, property expenses are tax-deductible. In a foreclosure, the unpaid debt generates a capital gains tax. Typically, there is a $3,000 write-off allowance for capital losses which may give funds back to the borrower, however, as an investment property, the foreclosure can result in tax liabilities. If you have questions regarding tax consequences of foreclosure of investment property, request a free consultation by completing this form.

How to Receive Tax Reporting Documents.

The necessary tax form, usually a 1099-A, is provided to each borrower by the lender to be filed with the IRS once the property is sold at auction. If you borrowed $175,000 to purchase property as a primary residence but unable to make the payments leaving a balance of $130,000 at foreclosure, the $130,000 is considered income by the IRS, as the lender supplied you with the money for the property but will not receive the remaining balance.

What Are The Consequences of Letting a House Go Into Foreclosure

When a home goes into foreclosure, the borrower loses the property to the lender. The repossession of the property does not relieve the borrow of liability. Any debt remaining after the property is sold at auction by the lender is subject to tax liabilities.

tax consequences of foreclosure

The foreclosure also appears as an adverse mark appears on the borrower’s consumer credit report for the duration of seven years. The consequences of home foreclosure may cause difficulty in securing other forms of loans to purchase automobiles and cause inflation of interest rates.

Legal Consequences of Foreclosure

In order for a lender to foreclose, legal action is required to be filed by the court regarding the delinquency on the mortgage loan. This action becomes a public record with the court in the county where the action is filed. The information will be published on your credit report and cannot be removed for a period of any less than seven years. The consequences of a short sale vs. foreclosure are vastly different. A short sale does not affect credit history adversely like foreclosure and is a voluntary agreement between the borrower and lender that does not require legal action.

FAQ Section

Will I owe money after foreclosure?

Possibly. If the home sells for less than what is owed on the mortgage, the lender has the right to pursue a deficiency judgment against the foreclosed homeowner.  It is best to consult with a foreclosure professional regarding specific circumstances.

How does home foreclosure affect your taxes?

Depending on your specific foreclosure situation you may owe taxes after the sale of your foreclosed property. In some circumstances, the unpaid debt may be classified as income and taxable.

How long does a foreclosure affect your credit?

7 years and more.

Can a bank go after other assets in foreclosure?

Possibly, if the property sells at auction for less than the total owed on the mortgage balance, a deficiency judgment is possible if filed by the lender after the property is sold at auction. This action can place a lien on assets or garnish wages. Judgments may be limited by the discretion of the court. Lenders of non-recourse mortgage loans cannot file a deficiency judgment.

Can you walk away from a mortgage?

Yes, it is possible, however, there are legal repercussions.

Be Prepared by Understanding Consequences of Foreclosure With Us

It is important to understand your rights and obligation if foreclosure is the only option. There are many important decisions that can affect the outcome of your decision. Request your free consultation by submitting this form to the Law Office of Yuriy Moshes, P.C.

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If you have questions regarding foreclosure and want to know your options, request your free consultation from the Law Office of Yuriy Moshes, P.C. by completing this form.