November 23, 2017

Should You Save Your Home from Foreclosure, or Should You Let it Go

With the news full of foreclosure statistics showing huge increases along with stories of self-righteous Members of Congress asserting their heartfelt concern for “struggling homeowners” little attention is paid to the question of whether a homeowner ought to fight to save his home.  My friend and colleague, Charleston bankruptcy lawyer Russ DeMott were recently discussing this issue and I invited him to prepare a guest post about this very topic:

Chapter 13 bankruptcy is a tool that can be used to save your home from foreclosure.  But the big question sometimes isn’t “can I save my home,” but “should I save it?”

We all know that there’s been an epidemic of foreclosure resulting from the recent economic downturn.  Jobs were lost, values plummeted, and foreclosures have been on the rise.

So it’s natural to wonder, “can I file Chapter 13 bankruptcy to save my home from foreclosure?”  However, when you meet with a bankruptcy lawyer to explore your options, you need to explore all your options—bankruptcy and otherwise.  And that might be not saving your home.

When you’re having financial problems and seek advice, you should take the opportunity to review your entire financial situation.  Can you afford your vehicle payments? Can you “tighten the belt” and cut back on some unnecessary expenses?  And most significantly, “should you try to save your home?”

In my Charleston, South Carolina bankruptcy practice, I get calls every week from folks facing foreclosure.  The potential bankruptcy client’s question is always a “can we?”  Can we stop foreclosure?  Can we make the lender listen?  Can we catch up on these payments we’ve missed?  Can we protect our home? Can Chapter 13 bankruptcy help?

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Are There Tax Consequences if You Surrender Your Home in Bankruptcy?

I recently received an email from a very concerned Chapter 7 client who I represented in 2006.  My client had suffered a fairly drastic reduction in his income and as part of his Chapter 7, he surrendered his home, which has a fair market value of approximately $650,000.  There were no objections in this case, and my client received his discharge as a matter of course.

Around the first of February, 2007, my client received a 1099 from the mortgage company showing that $599,000 of debt was forgiven.  I checked with my colleague, CPA Scott Rittenberg, who advised me that in a non-bankruptcy context, a homeowner who sells or loses a home to foreclosure could be liable for taxes on the difference between his basis in the home (in this case around $500,000) and the forgiveness ($599,000).  Would my client be looking at an income event in the amount of $99,000?

Scott did note that if my client had been in his home for two years or longer there was a $250,000 exclusion that applied, but absent a two year stay, there could be a tax problem.  Scott advised me to look further to research the rules about how a bankruptcy might change things.

I did a quick search on the BankruptcyLawNetwork blog and I found this post that answered by question about the tax treatment of a forgiveness of debt in bankruptcy by my colleague, attorney Cathy Moran of Mt. View, California.  Cathy publishes a very comprehensive and informative California bankruptcy law web site that speaks to many consumer bankruptcy issues.

Cathy advises that if you get a 1099, you should file a Form 982 to advise the IRS that the debt forgiveness occurred in bankruptcy and has no tax consequences.

2008 Update: you can read another informative post about the tax treatment of debt forgiveness in a bankruptcy on Taxgirl’s blog in a post entitled “Foreclosures, Debt Forgiveness and Mortgage Losses Explained.”  Click on the link to read this post.

Needless to say, my client is much relieved by the answer to his question.  Tax consequences arising from a deed in lieu of foreclosure in a non-bankruptcy setting could have significant and unintended consequences.  If you have option of executing a deed in lieu vs. a bankruptcy, keep the tax issues in mind.

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