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IRS Taxes on Foreclosed/Auctioned Rental property...Capital gain?

Walnut Creek, CA |
Filed under: Business


I bought a condo in Mar 2007 as a primary Residence, but due to financial hardship i moved to a cheaper place and rented this condo in 2009 Jan. On Sep 2011 Bank foreclosed this condo as i was not making payments from last 10 months.

My question is now that Bank Foreclosed the property and auctioned it for $149,000 and my loan balance was $303,000 on 1st and $45,000 on 2nd (Both loans purchase Money)...Do i have to pay Capital gain??

Please help

Attorney Answers 5


Your bank will issue you a 1099-B (I think) which will show you as having received sales proceeds of $348,000, that is the amount of the loan cancellation. Note they might go after you for the unrecovered balance, which I surmize as being $348,000 less $149,000, the amount they recovered, and of course they will have legal fees, etc. On your schedule D, you should show the sales proceeds, that being the amount of the 1099-B, then show your cost basis, which likely is less than the $348,000 generating a loss, which you can not deduct because it was a sale of a personal asset. Just show this also on your schedule D, that it was a personal asset and show the loss as a positive number so you end up with $0 loss. You want to show the 1099-B amount on your return because the IRS will try to match it up. ..................Now it gets complicated. You said you rented it. This converted the personal asset to a rental asset, perhaps. If you are successfull, then the asset is a §1245 asset and you can show the foreclosure on Page 2 of Form 4797, and write off the assets as a business loss....But this is tricky. The IRS knows what you are doing and why and you need to be need to consult a CPA

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Henry Daniel Lively

Henry Daniel Lively


The first hurdle you need to cross in California is whether this debt is recourse or non-recourse. If this is a purchase money note it is non-recourse by definition. If you refinanced the property or the note says otherwise it is probably recourse. The difference is important. Non-recourse debt is not subject to cancellation of debt income and the "sales price" used to calculate any gain or loss from the disposition of the property is different.


There would be no capital gains tax based upon your description of the facts.

The information presented here is general in nature and is not intended, nor should be construed, as legal advice. This posting does not create any attorney-client relationship with the author (who is only admitted to practice law in the State of California). For specific advice about your particular situation, consult your own attorney.

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If the bank does not pursue for the deficiency, you should report the gain on the sale. So-called "phantom income" on the sale of a principal residence can be excluded from income in certain situations. Can you show that you tried to sell the property before you moved? You should consult a tax attorney for further info.

Mark L. Rosenberg is an attorney admitted to practice in the State of Maryland and the District of Columbia only. This answer is meant to be for educational purposes and no attorney/client relationship is intended or created by this answer. You should consult an attorney in your jurisdiction for information on your case or claim.

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When a home is foreclosed you have two tax issues that you must consider. The first is the income from the cancellation of the debt. You must first determine whether the debt was non-recourse. If the debt was non-recourse there can be no cancellation of debt income. If this was the loan that you used to purchase the home then it is most likely non-recourse since it will be a purchase money loan. However, if you refinanced or the loan documents state otherwise, then this will be a recourse loan and subject to Cancellation of Debt Income. This income is taxable unless you qualify for an exclusion provided by the tax code or the Mortgage Debt Forgiveness Relief Act of 2007. You must look to the Act first and this must be your principal residence to qualify. This must also be Qualified Mortgage Debt. You may not qualify here because it does not look like you lived in the house as your principal residence for at least two years..

Next you need to look at the capital gains issue. Here, you take the Sales Price of the home, less the tax basis to determine if you had a Capital Gain. This can also get tricky and will depend on whether this debt was recourse or not. Whether the debt is recourse or not will determine the sales price that you use for tax purposes. Under the tax code a foreclosure is treated as a disposition of property and a sale must be recognized. Again, it appears that this is not your principal residence. Therefore, you will not be able to use the gain exclusion for a principal residence if you end up with a gain. You will most likely have a Capital Loss on this property. This cannot be determined by the facts you presented since you did not provide your acquisition price or other key data to compute this. Your tax preparer will need your original closing statement and the 1099 you receive from the bank to calculate this. Your tax basis will also be adjusted for the the depreciation that was allowed or allowable when you rented the property. This depreciation will also be subject to recapture. If you do not normally use a tax professional to prepare your return, I recommend that you use one for at least this year to make sure this is presented properly on your tax return.

Any individual seeking legal advice for their own situation should retain their own legal counsel as this response provides information that is general in nature and not specific to any person's unique situation. Circular 230 Disclaimer - Advice given in this response cannot be used to eliminate penalties with the IRS or any other governmental agency.

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I agree that the first question you need to ask is whether this could be a "capital" (generally, investment property) asset at all. That is a fact specific determination. Some of the factors include whether and how you advertised the property, whether you rented it to a friend or family member versus making it available to the public, and whether the rent was at fair market value. Here I do not believe that it would be treated as a capital asset allowing you to take a capital loss, in part because your investment in the property was for a majority of the time as a personal residence, and I don't think the facts are strong enough to support a business characterization for this property.

That said, the issue then is whether you have COD (cancellation of debt) income. The law says that you have COD income where you no longer have an obligation to pay an otherwise legally enforceable debt. There are exceptions to this rule, however. I believe here you would fall under the "insolvency" exception under IRC Sec. 108, which basically says that you will not be considered to have COD income by the amount by which you are "underwater" in your finances (that is, your liabilities minus your assets). In short, your tax consequences may be minimal. Tell your accountant to have a look at Form 982 when filing your return.

Hope this helps!

Ari Good, Esq. is licensed to practice law only in Florida, Illinois (inactive) and Washington, DC (inactive). Good Attorneys At Law maintains offices in Naples, Florida. The foregoing answer is for informational / educational purposes only: NOTHING IN THE FOREGOING ANSWER MAY BE INTERPRETED AS FORMING AN ATTORNEY CLIENT RELATIONSHIP NOR DOES IT CONSTITUTE TAX OR LEGAL ADVICE. Pursuant to Circular 230, nothing in the foregoing answer may be used for the purpose of avoiding penalties.

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