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IRS.gov Website
Publication 544
taxmap/pubs/p544-003.htm#en_us_publink100072291

Foreclosures
and Repossessions(p5)

rule
If you do not make payments you owe on a loan secured by property, the lender may foreclose on the loan or repossess the property. The foreclosure or repossession is treated as a sale or exchange from which you may realize gain or loss. This is true even if you voluntarily return the property to the lender. You also may realize ordinary income from cancellation of debt if the loan balance is more than the fair market value of the property.
taxmap/pubs/p544-003.htm#en_us_publink100072292

Buyer's (borrower's) gain or loss.(p5)

rule
You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. See Gain or Loss From Sales and Exchanges, earlier.
Deposit
You can use Table 1-2 to figure your gain or loss from a foreclosure or repossession.
taxmap/pubs/p544-003.htm#en_us_publink100072294
Amount realized on a nonrecourse debt.(p5)
If you are not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount you realize includes the full debt canceled by the transfer. The full canceled debt is included even if the fair market value of the property is less than the canceled debt.
taxmap/pubs/p544-003.htm#en_us_publink100072295

Example 1.(p5)

Chris bought a new car for $15,000. He paid $2,000 down and borrowed the remaining $13,000 from the dealer's credit company. Chris is not personally liable for the loan (nonrecourse debt), but pledges the new car as security. The credit company repossessed the car because he stopped making loan payments. The balance due after taking into account the payments Chris made was $10,000. The fair market value of the car when repossessed was $9,000. The amount Chris realized on the repossession is $10,000. That is the outstanding amount of the debt canceled by the repossession, even though the car's fair market value is less than $10,000. Chris figures his gain or loss on the repossession by comparing the amount realized ($10,000) with his adjusted basis ($15,000). He has a $5,000 nondeductible loss.
taxmap/pubs/p544-003.htm#en_us_publink100072296

Example 2.(p5)

Abena paid $200,000 for her home. She paid $15,000 down and borrowed the remaining $185,000 from a bank. Abena is not personally liable for the loan (nonrecourse debt), but pledges the house as security. The bank foreclosed on the loan because Abena stopped making payments. When the bank foreclosed on the loan, the balance due was $180,000, the fair market value of the house was $170,000, and Abena's adjusted basis was $175,000 due to a casualty loss she had deducted. The amount Abena realized on the foreclosure is $180,000, the balance due and debt canceled by the foreclosure. She figures her gain or loss by comparing the amount realized ($180,000) with her adjusted basis ($175,000). She has a $5,000 realized gain.
taxmap/pubs/p544-003.htm#en_us_publink100072297
Amount realized on a recourse debt.(p5)
If you are personally liable for the debt (recourse debt), the amount realized on the foreclosure or repossession includes the lesser of: You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. The amount realized does not include the canceled debt that is your income from cancellation of debt. See Cancellation of debt, later.
taxmap/pubs/p544-003.htm#en_us_publink100072300

Seller's (lender's) gain or loss on repossession.(p5)

rule
If you finance a buyer's purchase of property and later acquire an interest in it through foreclosure or repossession, you may have a gain or loss on the acquisition. For more information, see Repossession in Publication 537.
taxmap/pubs/p544-003.htm#w15074k03
Pencil

Table 1-2. Worksheet for Foreclosures and Repossessions

Part 1. Use Part 1 to figure your ordinary income from the cancellation of debt
     upon foreclosure or repossession. Complete this part only
     if you were personally liable for the debt. Otherwise,
     go to Part 2.
 
1. Enter the amount of outstanding debt immediately before the transfer of
  property reduced by any amount for which you remain personally liable after
  the transfer of property
2. Enter the fair market value of the transferred property
3. Ordinary income from cancellation of debt upon foreclosure or
   repossession.*
Subtract line 2 from line 1.
  If less than zero, enter zero
Part 2. Figure your gain or loss from foreclosure or repossession.  
4. If you completed Part 1, enter the smaller of line 1 or line 2.
  If you did not complete Part 1, enter the outstanding debt immediately before
  the transfer of property
5. Enter any proceeds you received from the foreclosure sale
6. Add lines 4 and 5
7. Enter the adjusted basis of the transferred property
8. Gain or loss from foreclosure or repossession. Subtract line 7
  from line 6
* The income may not be taxable. See Cancellation of debt.
taxmap/pubs/p544-003.htm#en_us_publink100072301

Cancellation of debt.(p5)

rule
If property that is repossessed or foreclosed on secures a debt for which you are personally liable (recourse debt), you generally must report as ordinary income the amount by which the canceled debt is more than the fair market value of the property. This income is separate from any gain or loss realized from the foreclosure or repossession. Report the income from cancellation of a debt related to a business or rental activity as business or rental income.
Deposit
You can use Table 1-2 to figure your income from cancellation of debt.
You must report this income on your tax return unless one of the exceptions below apply. File Form 982 to report the income exclusion.
taxmap/pubs/p544-003.htm#en_us_publink1000269417

Example 1.(p6)

Assume the same facts as in Example 1 under Amount realized on a nonrecourse debt, earlier, except Chris is personally liable for the car loan (recourse debt). In this case, the amount he realizes is $9,000. This is the lesser of the canceled debt ($10,000) or the car's fair market value ($9,000). Chris figures his gain or loss on the repossession by comparing the amount realized ($9,000) with his adjusted basis ($15,000). He has a $6,000 nondeductible loss. He also is treated as receiving ordinary income from cancellation of debt. That income is $1,000 ($10,000 − $9,000). This is the part of the canceled debt not included in the amount realized.
taxmap/pubs/p544-003.htm#en_us_publink1000269418

Example 2.(p6)

Assume the same facts as in Example 2 under Amount realized on a nonrecourse debt, earlier, except Abena is personally liable for the loan (recourse debt). In this case, the amount she realizes is $170,000. This is the lesser of the canceled debt ($180,000) or the fair market value of the house ($170,000). Abena figures her gain or loss on the foreclosure by comparing the amount realized ($170,000) with her adjusted basis ($175,000). She has a $5,000 nondeductible loss. She also is treated as receiving ordinary income from cancellation of debt. (The debt is not exempt from tax as discussed under Cancellation of debt, above.) That income is $10,000 ($180,000 − $170,000). This is the part of the canceled debt not included in the amount realized.
taxmap/pubs/p544-003.htm#en_us_publink100072303

Forms 1099-A and 1099-C.(p6)

rule
A lender who acquires an interest in your property in a foreclosure or repossession should send you Form 1099-A showing the information you need to figure your gain or loss. However, if the lender also cancels part of your debt and must file Form 1099-C, the lender may include the information about the foreclosure or repossession on that form instead of on Form 1099-A and send you Form 1099-C only. The lender must file Form 1099-C and send you a copy if the amount of debt canceled is $600 or more and the lender is a financial institution, credit union, federal government agency, or any organization that has a significant trade or business of lending money. For foreclosures or repossessions occurring in 2011, these forms should be sent to you by February 1, 2012.