The IRS has launched a special section of its website aimed at helping people who are facing foreclosure navigate the tax issues that surround debt forgiveness.
If debt is discharged and the amount totals more than what the home was worth, the difference is normally considered taxable income. The good news is that there is an exception to the rule for those who are really, truly broke.
From the IRS:
Borrowers whose debt is reduced or eliminated receive a year-end statement (Form 1099-C) from their lender. By law, this form must show the amount of debt forgiven and the fair market value of property given up through foreclosure. Though the winning bid at a foreclosure auction is normally a property’s fair market value, it may not necessarily reflect its true value in some cases.
The IRS urges borrowers to check the Form 1099-C carefully. They should notify the lender immediately if any of the information shown on their form is incorrect. Borrowers should pay particular attention to the amount of debt forgiven (Box 2) and the value listed for their home (Box 7).
Say, for example, that you’ve been foreclosed on and your home has a market value of $100,000. If you were forced to give the home back to the bank, they may have valued your home at something ridiculous like $1. This will leave you with an unreasonable and inaccurate tax burden. Check out the IRS website for more information about this issue. And just for good measure, here’s a basket full of kittens.