Tax Implications on Deed in Lieu of Foreclosure

What is a Deed in Lieu?

Various solutions can put a stop to mortgage foreclosure and help lessen the damage from non-payment of a mortgage debt. But with a deed in lieu, you agree to voluntarily surrender your home prior to the lender taking action to foreclosure. Deed in lieu's are useful when foreclosure is imminent or when borrowers have no other option for avoiding mortgage foreclosure. Lenders don't always accept this option. But if they do, you sign over the deed and vacate the property.

Consequences of Deed in Lieu

Signing over your deed doesn't eliminate credit damage. Voluntary repossessions or foreclosures do have an impact on personal scores or ratings. But according to Fannie Mae, the aftermath of a deed in lieu is often less severe than a mortgage lender foreclosing on a property. In fact, borrowers who sign over their deed can typically rebuild their credit faster and qualify for a new mortgage loan sooner than if they had lost the property to foreclosure.

Tax Implications

Credit damage isn't the only thing to concern yourself with after a deed in lieu of foreclosure. When agreeing to a voluntary repossession, lenders essentially forgive a percentage of the home loan debt. Lenders sell foreclosed homes to new owners. But oftentimes, the sale price of the property is less than the balance owed by the previous owner. For example, if a new buyer purchased a foreclosure for $120,000, but the original mortgage had a balance of $145,000, this equals a $25,000 deficiency. As the previous owner, you are required to pay income taxes on the forgiven deficiency balance.

Avoiding Tax Debt

Some previous owners are unaware of tax implications until they receive a notification. Previous owners who cannot meet this expense can file for bankruptcy to eliminate this financial obligation. Bankruptcy is also damaging to credit history and scores, and a bankruptcy stays on reports for 10 years. But while bankruptcies are devastating, improving credit habits or rebuilding credit can repair the damage, wherein you can possible reverse the damage after a couple of years, and then qualify for a new mortgage loan after two or three years.