Whether foreclosure is by choice or by happenstance, many homeowners are not aware of the hidden tax consequences of foreclosure. When homeowners lose their property to foreclosure, the mortgage lenders will likely try to sell the property to pay off the loans. In many cases, the properties will be up side down. In other words, the debtor owes more on the mortgage than the property is worth. The banks will then have no choice but to sell the properties at a loss. The original homeowner, technically, will still owe the bank for the residual balance. The same analysis is true for loans and credit card balances that are not paid.

When the banks are not able to recover the balance owed on the debts from the original borrower they will write off the balance as a loss. Once the banks write off the balance owed, they cancel the debt. At that point, the lending institution will be required to issue the debtor 1099-C, "Cancellation of Debt." A 1099-C will issue regardless of the banks have the current address of the homeowners. In many cases, homeowners do not know a 1099-C exists until after they have filed their taxes and they receive a deficiency notice or even worse, the IRS initiates an audit.

When homeowners receive a 1099-C, or when their debts are forgiven, they are required to report the forgiven debt as income on their tax returns. If not, there will be a discrepancy with the IRS and the taxpayer will then owe penalties and interest for the unpaid taxes. It is the taxpayer's responsibility to report all forms of income to the IRS. Not receiving (or ignoring) a 1099-C will not prevent the taxpayer from owing income taxes or penalties.

Many people may choose to file bankruptcy in order to "get a fresh start." Unless your attorney is aware of the forgiven debt and/or anticipates the receipt of a 1099-C, this amount will not be included in the bankruptcy filing and must still be reported as income. If you are facing a possible foreclosure, or have considered filing for bankruptcy or both, first see an attorney licensed in your state for legal advice on how to protect your interests and your rights.

For consultations, questions or referrals, or if you have additional questions or comments regarding this article, please call the Law Offices of Piet & Wright, Charles T. Wright Esq., at 1-866-373-0012 or (702) 566-4833 or visit us on the web at http://www.pietwright.com or by email at todd.wright@pietwright.com.