By Ryan C. Wood

These past couple years have been very hard on homeowners.  Homes are being foreclosed on left and right.  If you have been caught in this crisis as well you may need to know what your options are after your home is foreclosed and whether one of those options includes bankruptcy.

Many bankruptcy attorneys ran into all kinds of scenarios regarding foreclosure and potential resulting debts during the mortgage meltdown.  For many homeowners the foreclosure was not their only problem with debts and credit card debts were also a major problem.  Luckily there is the Bankruptcy Code that provides a legal discharge of personal liability for all debts incurred prior to filing.  

If your residential property was foreclosed and you only had one mortgage on the property then you may not need to file for bankruptcy since the creditors cannot go after you for any deficiencies due to the One Action Rule.  However, under normal circumstances, even if the creditors do not go after you for the deficiency you may still owe a hefty chunk to the taxing authorities, the Internal Revenue Service (“IRS”) and California’s Franchise Tax Board (“FTB”).  That is because the taxing authorities could treat the cancellation of debt as a taxable event since you did not have to pay the deficiency to the mortgage creditor, and thus the money you did not have to pay them is considered income in the form of a 1099-C.  This is a harsh double whammy for homeowners who have lost their home and now they have a hefty bill they need to pay the taxing authorities.  Hopefully if your CPA did not identify your tax debt is related to your foreclosure the bankruptcy attorney you consult with will.  Not all 1099-C income is a taxable event that must be added to income.

Since the foreclosure rates have been so high in the most recent years the federal and state governments have created temporary laws that would help ease the financial hardship of homeowners who have lost their homes.  IRS created the Mortgage Forgiveness Act of 2007 which forgives up to $1 million in debt for the deficiencies related to the foreclosure of a primary home for a single or married filing separate taxpayer and up to $2 million for a married couple.  The debt has to be related to the house, either building, improving or maintaining it.  There could be multiple mortgages on the house, and as long as they were all used for the property, you would not have to pay taxes on the cancellation of that debt.  The trouble that a lot of homeowners run into is the fact that sometimes the second mortgages are taken out to pay off their credit card debt or buy new cars which have nothing to do with the house.  If that is the case the deficiencies on that debt are still a taxable event to the IRS.

California has a similar program that protects homeowners who have lost their homes in a foreclosure.  They exclude up to $250,000 of debt for deficiencies related to foreclosure of a primary residential property for a single or married filing separate taxpayer and up to $500,000 for a married couple.

Since both the federal and state governments are protecting only primary residences, if you have a rental property, or business property, or even second mortgages that were taken out to pay off debt that is not related to your home, the cancellation of such debt are still considered taxable events.  Be sure to seek the consultation from an  experienced bankruptcy attorney and not an attorney just jumping on the band wagon when the economy turns sour.