If you still owe money on a property’s original mortgage, or if you have taken out a line of credit on the property or used the property as collateral for a loan, the creditor with whom you take out the mortgage, line of credit or loan, may foreclose on the property if you fail to make payments. If this property is an investment property, the foreclosure cannot be written off, but may have implications on your income taxes.
What Happens in a Foreclosure
When a creditor forecloses on a property due to non-payment on a mortgage or loan, the creditor takes possession of the property. At that point, the creditor usually attempts to sell the property to recoup some of the money lost on the loan. Once the property sells, if the sale price doesn’t cover the remaining balance of the loan, you may or may not be responsible for the balance of the loan.
If the difference between the balance of the loan and the sales price of the foreclosed property is only a few thousand dollars, a creditor may not attempt to collect the remainder of the loan from you and may simply write the remainder of the loan off instead. If this happens, the amount of the loan that gets written off by the creditor is considered cancelled debt, which is treated as a capital gain for tax purposes.
Foreclosure Capital Gain
To report a capital gain due to an investment foreclosure, you must list the gain from the foreclosure on your tax return, also known as Form 1040, and also fill out Schedule D of Form 1040. The total gain for the foreclosure is the remaining balance of the loan minus the amount for which the property sells. If the balance left on a loan is $100,000, for instance, and the creditor sells the property for only $65,000, the $35,000 difference is the capital gain from the foreclosure.
Generally an investment property does not serve as a primary residence, but if you are using a property originally purchased as an investment for your primary residence, the foreclosure of the property qualifies for exemption from taxes, as of the time of publication. This remains true even if the creditor writes off a portion of the original loan. You also don’t have to report a capital gain on a foreclosed property if the property sells for more than the balance that remains on the loan.
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