Facing Foreclosure: Answers to the top 7 Legal and 7 Tax Questions

This is a guest article by Houston Bankruptcy Attorney Adam Schachter.

Home Foreclosure Legal Questions

1. Can I transfer my home to a friend or family member to avoid foreclosure?

No. The lender has a contract with you that imposes obligations on you and gives the lender an interest in the property. If the mortgage is not paid and the lender takes all the necessary steps to foreclose, transferring the property to someone else will not stop a foreclosure. If you end up seeking a bankruptcy lawyer’s, this property transfer could actually make it more difficult, if not impossible, for the lawyer to help you.

2. Can I keep my house if I declare bankruptcy?

Absolutely, with some conditions. You need to be able to make the regular mortgage payments on the house, as well as keep insurance on it. You need to also make sure the property taxes are paid as well as any homeowner’s association fees if you have them. If you are using bankruptcy to stop a foreclosure, you will likely file chapter 13 bankruptcy which is a plan of reorganization. As part of this plan of reorganization, you not only have to be able to do all the things I mentioned, you also have to show that you are able to catch up the arrears. You have up to 60 months (5 years) to catch up the arrears.

3. How can I save my house other than declare bankruptcy?

Unfortunately, for many people, Chapter 13 bankruptcy ends up being the only way to save their house. Our experience shows that for many people, Chapter 13 is often the best way since there is no more hassle of dealing with lenders who seem unwilling or unable to work with you.

Outside of bankruptcy, there are several options. One is to contact the mortgage lender for a loan modification. This involves a mountain of paperwork and very often leads to little relief. Another is the governments Home Affordable Modification Program. I would caution people not to pay for help in filling out the necessary documentation unless you are truly overwhelmed. Understand that when you pay someone to help you fill out these forms, they are NOT guaranteeing that you will get help with your mortgage. You are only paying for their time in assisting you with the forms.

4. Why am I getting mail about a foreclosure when my bank said they would work with me?

Because the people working at your bank often do not communicate well with one another. Also the person who told you on the phone that said the bank would work with you often has no control over whether the bank will move forward with foreclosure. DO NOT TRUST what is told to you on the phone. ONLY trust what you get in writing from the bank. We have seen people lose their homes because they are told on the phone that the bank will work with them. Then their home gets sold at foreclosure and there is little they can do.

5. Will I receive any money or owe any money after foreclosure?

Theoretically you could receive money after foreclosure. This would occur if the house sold for more than what was owed, after deducting expenses and costs of sale. If the house was sold for less than what was owed, you owe the difference between the sales price and the amount on the loan and you must add on the costs of sale.

6. My house is sold at foreclosure, what’s next?

What’s next is that mortgage company will want you to move. This process can be as quick as a few weeks but most of our clients who have given up their homes see the process taking several months. First the lender sends a letter that the house is foreclosed and asking you to move. Next, the lender will send a formal notice to vacate. If you still haven’t moved the lender will file an eviction suit. This gives the lender the right to take more drastic action, such as moving all your property on the street and changing the locks, so it’s best to get out as quickly as possible.

7. If my situation improves, can I buy my house back?

Not if you lost your home to foreclosure due to a bank loan. If you lost it due to a property tax foreclosure, it is possible to get it back through a complicated and expensive process called “redemption.”

Home Foreclosure Tax Questions

1. My own house is being foreclosed. How much tax will I owe the IRS?

In a typical case, you will not owe any IRS taxes and will not even need to report the foreclosure to the IRS. However, if your mortgage company ends up sending you an IRS Form 1099-C (Cancellation of debt income), you will need to complete an additional IRS Form 982 and include it with your tax return. Of course, there are some unusual situations that may trigger IRS taxes on foreclosure of personal residence, but such situations are quite rare.

2. My rental property is being foreclosed. How much tax will I owe the IRS?

Unfortunately, this is a very complex question. There are two separate issues to consider. The first issue is capital gain or loss. For this calculation, foreclosure is treated as a sale. The second issue is cancellation of debt, which can happen if your loan balance was higher than what your house was worth, and the bank forgives the remaining unpaid balance. While the idea may look simple, the calculations are not. Read this article if you want to learn more The good news is that, when the dust settles, most of my clients end up paying less taxes rather than more taxes after foreclosure of investment property. But your mileage may vary.

3. When do I have to pay the IRS - before or after foreclosure?

As I explained earlier, you may not owe the IRS extra taxes after foreclosure. But if you do owe taxes, you will owe them when you file your next tax return. The IRS is not part of the foreclosure process.

4. What if I have no money to pay the IRS?

Millions of people owe money to the IRS. Whether the IRS debt relates to foreclosure or to something else - does not matter. The process is the same. You need to contact the IRS and make arrangements. Depending on your situation, such arrangements may include a payment plan (“Installment agreement”), a settlement (“Offer in compromise”), or temporary relief. Some of these options are very easy and can be accomplished with a single phone call to the IRS. Other options can take months and require professional help. But whatever you do, NEVER ignore the IRS letters. The IRS will not leave you alone, and if you ignore them long enough, they will start collecting from you. Unlike the relatively harmless phone collectors from credit card companies, the IRS collectors have huge powers: they can grab your bank accounts, your paychecks, your retirement money, and even part of your Social Security. Do not let the situation come to this crisis point: respond to those letters and find a solution before it is too late.

5. I am being foreclosed. Does it mean I will be audited by the IRS?

No. Foreclosure does not trigger an IRS audit. However, if you received some foreclosure-related IRS forms, specifically 1099-A and/or 1099-C, you may have to include those numbers on your tax return. If you do not, the IRS may start writing you letters asking for clarifications or for extra taxes. As far as IRS audits, they can audit anyone anytime - foreclosure or not.

6. I am being foreclosed, and I already owe money to the IRS. Is that a problem?

Owing money to the IRS does not change the foreclosure process, unless you have an IRS lien, which is explained below. If foreclosure creates additional IRS taxes - your total debt to the IRS goes up, and you need to address your overall IRS debt. If (and it is more likely) your foreclosure results in a tax loss, and your tax return shows a refund from the IRS - you will not receive the refund. Instead, it will be automatically applied towards your debt, even if you have a payment plan (installment agreement) in place.

7. I am being foreclosed, and I have IRS Federal lien. How does it work together?

This can get complicated and may require assistance from a tax professional. In the simple case, the foreclosure money goes to your mortgage company, and this lender is still short. There is no money left for the IRS. The IRS lien stays in place, especially if you have some other properties. If your lender receives more money from selling your foreclosure than your loan balance, the extra money will be sent to the IRS and not to you. Whatever the case, normally your lender will deal with the IRS lien and let you know if you need to be involved.