Many people worry about the tax ramifications of canceled debt and foreclosures when they consider filing for bankruptcy, and rightly so. No one wants to get the “fresh start” bankruptcy affords just to be hit with massive taxes the following April. However, when you receive a discharge of your debts in bankruptcy, you do NOT have to pay taxes on those discharged debts. But what if you don’t file for bankruptcy and a debt is just “charged off” or your home foreclosed upon?
As of today, the Mortgage Debt Forgiveness Act has not been extended. This is the program that Congress was supposed to extend last year and has not yet made the decision to do so. It expired on Dec. 31, 2013. However, most people believe this will be extended retroactively here very soon (sometime in the Spring 2014). However, if the Act is NOT extended, homeowners could definitely be liable for the forgiven or “canceled” debt associated with foreclosures. The same is true for other canceled or “charged off” debts including credit cards, medical bills, etc.
Insolvency is one way to avoid these taxes. You are insolvent if, at the time the debt is forgiven, your total debts are more than the fair market value of your total assets. This would be something that you would have to “take up” with the IRS if you received a 1099C from any of the banks or creditors who foreclosed or “charged off” any of your debt. Please visit IRS.gov for a complete list of criteria to avoid paying taxes on canceled debts. Filing bankruptcy would avoid all liability for any canceled or forgiven debt, so please speak with one of our experienced attorneys at Jeff Field & Associates today and let us help you through this difficult financial time.