If we are in bankruptcy and decide to let our house go..do we get taxed on the difference after sheriff’s sale.

Asked on June 30, 2009 under Bankruptcy Law, Ohio

Answers:

M.D., Member, California and New York Bar / FreeAdvice Contributing Attorney

Answered 11 years ago | Contributor

There is a difference between a sheriff's sale and a short sale.  If this is a sheriff's sale, and the property is sold at a loss,  then no you should have no tax liability.

By way of explanation, if the homeowners work out a short sale before the foreclosure, and the bank accepts less than what they are owed there would be income to show.  The difference between what is owed and what the bank accepts is counted by the IRS as "forgiven debt" and is taxable income.  But this is only if there is an agreement between the homeowners and the lender to proceed with a short sale. 

If there is a forced sale of the property at county auction and it sells for less than what was owed at the time of sale, that indicates that the homeowners received no proceeds from the sale.  If there is a loss then there is no tax is due.  In the case of a foreclosure, where the house is ordered to be sold to satisfy the mortgage debt, the bank will usually have a judgment against the homeowners for the full amount owed on the mortgage (or more, with fees and court costs).  Just because the house sells for a loss at the sheriff sale does not mean they forgave any of that debt.  The house simply sold for less than what was owed, no portion of the amount owed was forgiven.  Thus, with no forgiven debt, there is no taxable income.

Notwithstanding the above, in bankruptcy case, The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence.  Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualify for this relief.


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