Michael H. Lester, J.D., CPA
Business Management

1990 Westwood Blvd. #200
Los Angeles CA 90025
Phone: (310) 446-0088; Facsimile: (310) 446-0079

"TIP OF THE MONTH"
(October 1996)

Foreclosure and Income Taxes.
Watch Out!

One of the most traumatic financial experiences you might suffer in life is the loss of your home in foreclosure.

Being displaced in this manner can cause severe psychological damage to individual family members and to the family as a whole.

Unfortunately, the financial disadvantage may not end with the loss of your home. You may also suffer serious adverse tax consequences as a result of a foreclosure.

In most cases, when you make a mortgage payment, the lender applies your payment first to interest, then to principal. Then, if you otherwise qualify, you can deduct the mortgage interest you paid on your income tax return.

However, in foreclosure, the law may require that the foreclosure proceeds apply first to principal. This rule applies if you were insolvent at the time of the foreclosure sale, and if the lender sold your home for less than the principal amount of the loan. In this case, you cannot deduct accrued but unpaid interest on your income tax return.

You may suffer an even worse tax consequence if the lender or the law relieves you of responsibility for the mortgage balance, and the mortgage balance exceeds your tax basis in your home. In this case, the excess of your mortgage over your tax basis may be income to you in the year of foreclosure.

Caveats

This is only a general discussion of some of the rules about "Income Taxes and Foreclosure." There are more details, special rules, and exceptions not discussed here. You should consult a professional tax advisor if you are not sure how the rules apply to your particular situation.

As always, general advice may not apply to your specific situation, and rules change constantly, so you should get a professional opinion before you rely on this information.

Prior Months' Tax Tips

Read the "Tip of the Month" for April 1996. "Nanny Taxes"
Read the "Tip of the Month" for March 1996. "When Do You Need Receipts for Charitable Donations?"
Read the "Tip of the Month" for February 1996. "Who Qualifies as Head of Household?"
Read the "Tip of the Month" for January 1996. "Save Taxes. Open an Individual Retirement Account."
Read the "Tip of the Month" for December 1995. "Economic Reality Audits. Should You Be Afraid?"
Read the "Tip of the Month" for November 1995. "Should You Buy or Lease Your Next Car?"
Read the "Tip of the Month" for October 1995. "Save Taxes! Put Your Junior Programmers to Work"
Read the "Tip of the Month" for September 1995. "California Statutory Wills"

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