It seems a little unfair to the homeowner considering how difficult a foreclosure can be for a homeowner and all of the stress that it brings about, but anyone facing foreclosure should always take tax consequences into account. If a debtor has bad debt and the creditor agrees to accept the loan collateral in satisfaction of the debt (for example they may take your home in the case of a mortgage or they may just foreclose the collateral), this amounts to a sale of the property. This means that the debtor will most likely have cancellation of debt (COD) income or some capital gain. If the fair market value of the property is less than the debt, the debtor will have COD income…it sounds unfair considering the homeowner has now just lost their home, but there are always taxes no pay on capital gains (or COD income).
On the other hand if the creditor accepts a deficiency note to cover the amount of the debt less the property, the debtor may avoid COD income. If the transaction results in a capital gain, which depends on the difference between the fair market value of the property and the original cost minus depreciation and rose by capital improvements, the tax rate is usually about 15 percent for capital gains.
Not only is a foreclosure the homeowner’s loss, but also a loss for the lender. To get an estimate of what your lender may stand to lose, first you must obtain an estimate of the property’s current market value from a Realtor or an appraiser (if you have one that is less than 90 days old already, that should be ok). Then you figure out the amount you currently owe on your home by contacting your lender and asking for your principle balance, or just by checking your most recent mortgage statement. Finally you subtract what you owe on the home from the current market value.
If the result is a negative number, your lender stands to lose money if the home forecloses. The larger the number, the more they lose.
The lender may also lose money in attorney’s fees, real estate agent commissions, holding costs, and rehab costs for repairs.
So, a foreclosure is pretty much the worst option for all parties involved. Homeowners lose their homes and it affects their credit in the long run, lenders lose the costs of the foreclosure and performing assets, the property values in a neighborhood typically drop nine percent per foreclosure, which is bad for the neighbors, and the economy ultimately suffers. So if you are ever thinking that walking away from your home is the easiest way out you may want to think again.