What if my house sells for less than I owe in a foreclosure?

If your house is sold at auction or is transferred to the lender and the amount for which it was sold or transferred is not enough to cover the balance of your loan, the financial institution, with certain exceptions, may have to cancel or forgive the balance between the fair market value of the house and the amount you owe. This balance or deficit is also known as "cancellation of debt." The institution will file the applicable IRS forms with the amounts owed and other relevant information. You will receive a copy of the applicable 1099 forms in reference to the amount "forgiven." With certain exceptions, you may have to include this amount as part of your income when you file your income taxes. Talk to a tax adviser about the potential impact on your tax filings.

The "Mortgage Forgiveness Debt Relief Act," which amemded the Internal Revenue Code, provides with additional exclusions for some homeowners who lost their homes, if occupied as their primary residence, to foreclosure and the lender canceled or "forgave" a portion or the total debt secured by the house. This new law can be applied for residential discharged debts of up to $2 million ($1 million if married filing separately) made on or after Jan. 1, 2007, but before Jan. 1, 2012.

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