TaxAlmanac:Featured article/August 28, 2007
From TaxAlmanac
Home Foreclosures (FAQs)
Why is it that I may have both gain (or loss) and cancellation of debt (COD) income upon foreclosure of my house? In many home foreclosures, the mortgage debt is recourse and the fair market value (FMV) of the house is less than the unpaid face amount of the debt. Often in this situation the borrower/debtor transfers the house to the lender (or to a third party), either through a deed in lieu of foreclosure or as a result of a foreclosure proceeding. This transfer is treated as a sale or other disposition of the property and results in the borrower/transferor realizing gain or loss. At the time of the transfer, the lender often cancels the remaining mortgage debt, leading to COD income.
Different rules may apply if the mortgage debt is nonrecourse.
What is COD income, and how is it calculated? Loan proceeds are not included in income when received because there is an offsetting obligation to repay. However, if the debt is cancelled in part or full in a foreclosure proceeding, you will have COD income equaling the difference between the unpaid amount of the debt and the FMV of the property you transfer to the lender or a third party to discharge that debt. For example, if your debt prior to foreclosure was $200,000 and the FMV of the property was $170,000, you would have $30,000 of COD income.
Note: If you borrow money from a friend or relative and he or she cancels all or part of the debt, the cancellation often is treated as a gift from the lender to you. Gifts, including gifts of cancelled debts, are excludible from income. However, the cancellation of debt by a commercial lender is not a gift.
