Foreclosures and Taxes: What Are the Tax Consequences?

A foreclosure is the process where a lender repossesses a property after a borrower fails to make mortgage payments. The Internal Revenue Service (IRS) considers a foreclosure a taxable event. Losing a home this way is treated by the IRS as a sale of the property, which can generate tax consequences that homeowners may be unprepared for.

The Two Parts of a Taxable Foreclosure

The IRS views a foreclosure as two separate transactions, each with its own potential tax impact. The first part is the sale of the property, where you must determine if you have a capital gain or loss. The second part is the potential cancellation of debt, which can create taxable ordinary income.

A loan is categorized as either recourse or nonrecourse debt, and this distinction is central to how the foreclosure is taxed. Recourse debt holds the borrower personally liable for the entire loan balance, even if the home’s sale price does not cover the full amount. With nonrecourse debt, the lender’s only option is to seize the property that secures the loan and they cannot pursue the borrower for any shortfall.

Calculating Gain or Loss from the Property Sale

Every foreclosure includes a “sale” component for tax purposes, which may result in a capital gain or loss. To determine this, you must compare the property’s amount realized to your adjusted basis. The adjusted basis is the original purchase price of the home, plus the costs of any significant improvements. The calculation for the amount realized changes based on whether the loan was recourse or nonrecourse.

For a nonrecourse loan, the amount realized is the full outstanding mortgage balance at the time of the foreclosure. For example, if the outstanding debt was $300,000, this is your amount realized, regardless of the home’s market value. If your adjusted basis was $220,000, you would have an $80,000 capital gain, which may be excludable if the home was your primary residence.

With a recourse loan, the amount realized is the lesser of the property’s fair market value (FMV) at the time of foreclosure or the outstanding debt balance. If your outstanding recourse debt was $300,000, but the home’s FMV was only $250,000, your amount realized from the sale is $250,000. If your adjusted basis was $220,000, you would have a $30,000 capital gain. A loss on a personal residence is not deductible.

Identifying Cancellation of Debt Income

The second potential taxable event in a foreclosure is Cancellation of Debt (COD) income. This type of income is unique to foreclosures involving recourse debt. COD income is generated when the lender forgives a portion of the debt because the home’s value is not enough to cover the entire loan balance, which represents an increase in your net worth.

The formula to determine COD income is the amount of outstanding recourse debt immediately before the foreclosure, minus the home’s FMV at that time. Following the previous recourse debt example, if the outstanding loan was $300,000 and the home’s FMV was $250,000, the lender might forgive the $50,000 difference. This $50,000 is considered COD income and is taxable as ordinary income unless an exclusion applies.

Common Exclusions for Canceled Debt

Even if a foreclosure on a recourse loan generates Cancellation of Debt (COD) income, you may not have to pay tax on it. The tax code provides several exclusions that must be applied in a specific order. These exclusions apply only to the COD income portion of the foreclosure, not to any capital gain from the property sale.

The first rule to apply is the bankruptcy exclusion, as any debt discharged in a Title 11 bankruptcy case is fully excluded from income. If not discharged in bankruptcy, you next consider the insolvency exclusion. You are insolvent if your total liabilities exceeded the fair market value of your assets immediately before the debt was canceled, and the amount you can exclude is limited to the amount by which you were insolvent.

The Qualified Principal Residence Indebtedness (QPRI) exclusion is applied last. This provision allows taxpayers to exclude COD income from the foreclosure of their main home, up to $750,000 ($375,000 if married filing separately). This provision has been extended through the 2025 tax year.

Tax Reporting for a Foreclosure

After a foreclosure, you will receive specific tax forms from your lender. The first is Form 1099-A, Acquisition or Abandonment of Secured Property, which provides details about the property sale. If your lender also forgave a portion of your mortgage, you will receive Form 1099-C, Cancellation of Debt, which reports the amount of debt canceled.

If you have COD income but qualify for an exclusion, you must file Form 982, Reduction of Tax Attributes. On this form, you will indicate which exclusion you are claiming, such as the bankruptcy, insolvency, or QPRI exclusion. Filing this form is required to officially claim the exclusion.

The foreclosure event is reported across different parts of your tax return.

• The sale of the property is reported on Form 8949, Sales and Other Dispositions of Capital Assets.
• The resulting gain or loss is carried to Schedule D, Capital Gains and Losses.
• Any taxable COD income, after accounting for exclusions on Form 982, is reported as “Other Income” on Schedule 1 of your Form 1040.