Recourse or Non-Recourse Loan

• Foreclosures of recourse and non-recourse loans have different tax consequences. In a non-recourse loan, the lender's only remedy for a default is to foreclose on the property; the borrower has no personal liability. The express terms of the loan can state that it is non-recourse. Some loans become non-recourse because of the application of state laws that shield borrowers from liability for a deficiency.
  
  

Cancellation of Debt Income

• Foreclosure of a recourse debt will result in cancellation of debt income ("COD income") if the bank forgives the rest of the obligation after foreclosure. Basically, the homeowner borrowed money that he does not have to repay. The IRS treats that free money as income.
  
  

Capital Gains

• Capital gains occur when the net proceeds realized from a property sale (including a foreclosure) exceed the owner's tax basis in the property. In a non-recourse mortgage foreclosure, the IRS calculates the net realized proceeds based on the greater of the actual foreclosure sale price received or the amount of unpaid non-recourse debt at the time of the foreclosure. As a result, capital gains may arise if the non-recourse loans on the property are more than the purchase price for the house and the cost of capital improvements.
  
  

Exclusions

• The Internal Revenue Code includes exclusions from COD income and capital gains for some homeowners who lose their primary residence to foreclosure.
  
  

Tips & Warnings

• Anyone who loses a property to foreclosure should consult with a tax professional to determine the tax consequences of their specific situation and to seek assistance with properly reporting the foreclosure to the IRS and claiming any available exclusions.