Many folks are re-evaluating their financial positions and some are second guessing their investing over the past three to five years. When times are good in our economy, some take risks that they might not take in market that is not as favorable. I have heard recent talk of people wanting to let properties go to foreclosure. Remember that foreclosure is kind of like bankruptcy – it should be your last option. Foreclosure will also live to haunt you for a long time after the initial sting is gone.
Foreclosure has tax consequences that most overlook and may bring back that pain a year later. I was recently speaking with one of my clients who works with a lot of real estate investors. He asked me some valuable questions with hard answers that I think a lot more people should hear to understand the long term effects of foreclosure. Let’s look at an example:
- Property purchased in 2005 for $700,000
- He put 10% cash down and has an interest only mortgage; so mortgage balance is currently $630,000
- Bank forecloses and sells for $400,000
- The bank either holds the owner liable for the remaining $230,000 ($630,000 mortgage less $400,000 received in sale – note there are probably other bank fees to add to the recoverable amount from the bank, but we have dismissed these for this example)
- OR bank cancels the remaining debt of $230,000 if it believes it is uncollectible
- The owner receives a cancellation of debt 1099 for $230,000 that is TAXABLE. This generates a balance due of approximately $85,000 (depending on tax rates for federal and state).
Now, let’s look at the alternatives. Chances are very good that the bank will sell the property for less than you can even at a “fire sale” price. Try your hardest to dump the property through a sale before it goes to foreclosure. This will also help salvage your future credit report – the foreclosure would stay on your report for the next seven years.
Also, if you will need to come up with $85,000 to pay the IRS that you will never see again – it would have only cost you $44,100 (assuming 7% interest) in payments to hold the property for another year and attempt to wait out the market or find a buyer.
Donna Bordeaux is a Certified Public Accountant and Personal Financial Specialist with Bordeaux & Bordeaux, CPAs, PA in Lake Wylie, SC (a suburb of Charlotte, NC). For further information about Donna or her firm, please visit www.charlottecpafirm.com.