Legal Question in Real Estate Law in California

Foreclosure and Taxation

If a lender forecloses on a property, I understand that they will 1099 the borrower for the difference between the loan amount and the final sale of the property.

For example, if the final trustee sale is $550,000 and the loan amount is $650,000 that LOSS of $100k is treated as INCOME to the borrower via a 1099 from the lender.

So if the borrower has a job and makes $40k, his actual TAXABLE income now will be $140k.

Is this correct???

How can the borrower minimize this humongous tax burden??

I have a friend that has medical issues and will get his house taken away. I feel bad for him, but I want to prepare him for the 1099 because I honestly feel he is totally unprepared for a tax burden for $140k income vs 40k income. I KNOW that he will get taxed at a much higher rate.

Does he need to show loses ?? I mean how much deduction can someone show with that high of an income bracket?????


Asked on 10/16/06, 8:24 pm

2 Answers from Attorneys
Anthony Roach Law Office of Anthony A. Roach

Re: Foreclosure and Taxation

Huh?

If the property yields $550,000.00 and the loan was $650,000.00, the bank loses $100,000.00. This is called a deficiency. If the bank forecloses by a nonjudicial foreclosure sale, the bank is out $100,000.00. There is no 1099 for income. Who told you that?

If the bank forecloses judicially, meaning they file a lawsuit, they still would be unable to get a deficiency judgment if the loan was what is known as a purchase money mortgage. This rule would not apply to a refinancing transaction.

It seems to me that tax wise, if the house sells for less than the loan, your friend does not have a gain, but rather a loss, and his tax burden should be less. In other words, the house sold less than it was bought for, unless your friend had a huge loan and blew that $100,000 extra at a party.

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Answered on 10/16/06, 9:34 pm
Bryan Whipple Bryan R. R. Whipple, Attorney at Law

Re: Foreclosure and Taxation

I'd be cautious here! In some circumstances, borrowing $1.00 and only repaying 85c can result in 15c of taxable income. Discharged debt is often taxable income to the borrower. I'm not a tax expert, but I do know of instances where this has happened to an unwary borrower.

The key to avoiding a tax wipe-out may be that there could be an offsetting or partially offsetting loss on the sale of the house vs. the purchase, e.g. if it were financed for $650,000 it may have been purchased for $700,000 (with $50,000 down), and thus there is a $150,000 capital loss when the foreclosure nets $550,000.

Better see a tax expert pronto.

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Answered on 10/17/06, 3:24 am


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