The IRS says there is no free lunch. If you transfer title on your home, whether voluntarily through a warranty deed or grant deed, or involuntarily through foreclosure, you have sold your home. You might be subject to taxes, even if you sold your home at a loss, either on a short sale or by foreclosure.
It doesn't seem fair. What's worse is you might not even find out that you owe taxes until the day you open your mail to find a 1099.
I spoke with Julian Block, an attorney in Larchmont, NY, who has been cited by The New York Times as a leading tax professional. Here is what he has to say about taxes, gains and losses on distressed sales such as foreclosures and short sales:
Julian Block on Gains and Losses
"Sellers who have owned their personal residences for lengthy periods still will realize gains.
"But sellers of residences acquired within the past two years or so are going to incur losses. Even assuming no price declines, losses will result because of expenses for real estate brokers, lawyers and the like. Sellers will not be able to deduct those losses. Makes no difference that they are forced to sell because of, for instance, job changes or health reasons. "Besides problems for sellers of personal residences, there are tax troubles for investors who, say, bought several condos in places like Florida and are unable to flip them because prospective buyers are waiting for further price declines. Often, it is not worthwhile for those investors to rent their places; what they receive as rent payments will be insufficient to cover their real estate taxes and mortgage interest. Their only option is to sell at a loss.
(Rated by 5 Council Members)