In other words, if you lose your property in a foreclosure sale, you will be liable to the IRS for taxes if the adjusted cost basis of your property is less than the sales price at the foreclosure sale. You may even face a tax bill for capital gains if your lender forecloses and sells your property for more than you originally paid plus capital improvements, even if you dont get a penny back. Tax Liability If You Sell Your Property in a Short Sale As an alternative to foreclosure, some property owners reach agreement with the foreclosing lender to sell the property in a short sale for less than the balance of the loan.
When your lender releases you from paying the deficiency, it is known as discharge of debt and is considered taxable income by the IRS. In fact, your lender will submit a Form 1099A to the IRS which will reflect the amount of the discharge. Income Tax Liability Exceptions Several IRS exceptions may relieve you of tax liability for a discharge of debt Bankruptcy exception.