Facing foreclosure

More Californians confront mortgage payments that they cannot pay, or interest rate resets that will soon make payments unaffordable. Whether or not you decide to keep the house, there are bankruptcy options and alternatives.

 

Keep the house

If your decision is to try to cure payment defaults and keep the house, Chapter 13 can provide a court enforced repayment plan that brings the mortgage current over time.

You should consider seriously whether it makes sense to keep the house. Sometimes keeping a heavily encumbered house makes neither economic nor emotional sense.

 

Surrender the house

Many homeowners have several mortgages on their home. Often the creditor who initiates the foreclosure is the holder of the senior mortgage.

If the senior lienholder completes a foreclosure (which destroys any junior liens) the junior mortgage or HELOC lender typically has the right to sue the borrower for the loan balance. The obligtion to that cut off junior lender can be discharged in bankruptcy. More about how foreclosure works.

Tax consequences of foreclosure

An ugly, and often unexpected, follow-on to foreclosure is receipt of an IRS form 1099(c), treating the foreclosure just like an arm's length sale which netted the former homeowner proceeds that may be taxable capital gains. Thus there may be a tax obligation on money you never saw!

If the foreclosed property is a qualifying home, the gain triggered by the foreclosure may be sheltered by the homeowner's exclusion, which is currently $250,000 for each spouse on title.

In California, where home values have increased dramatically over the past several decades, homeowners have often taken equity out of their homes via refinancing. As a result, there may be substantial taxabale gain in excess of the amount of the exclusion, triggering a tax debt.

 

A solution to the threat of taxes following a foreclosure may be found in Chapter 7 bankruptcy. The bankruptcy estate created when a case is filed by an individual is itself a taxpayer, separate from the individual. If the foreclosure takes place when the encumbered house is property of the bankruptcy estate, the tax consequences fall to the bankruptcy estate, not the debtor.

It is worth considering a Chapter 7 prior to a foreclosure when the sale is likely to generate taxes.

Consider also the issue of forgiveness of debt income which may be triggered in a short sale or some foreclosure situations. IRS on Mortgage Debt Forgiveness Act. Cancellation of debt icome in bankruptcy in general.

 

As you can see, there are a number of complex factors at work in these situations. An experienced bankruptcy lawyer can help you assess the options and alternative.