1. Bank would try to collect against your other assets and wages. 2. When bank determines that you have nothing left, it will "forgive the debt" and write it off. 3. When bank "forgives debt", the amount of forgiven debt becomes ordinary income to the defaulter and is taxable. So, the bank might leave the defaulter alone at this point, but now the defaulter has to contend with the IRS asking for the tax money.
What?? Are you serious? After the bursting housing bubble has put the poorer half of Americans into bankruptcy, the government is going to slap them with tax bill! Absolutely ridiculous. Just can't be true.
Unfortunately, that's how it works. For the lender to be able to write off the loss, it is a *requirment* that he 1099 the borrower for the defaulted amount.
Have you EVER had a client that defaulted and was imposed a tax bill for "forgiveness of debt" on a home. In California, I've had a few that defaulted, received notice (1099) and never paid one red cent to the IRS under this theory. The forgiveness of debt concept gnereally works when two parties are involved in a business transaction with no security. With a home sale/purchase you have a three headed monster; Buyer, seller, banker and security. If someone got hit for this they had really bad counsel representing them before the IRS.
Not an expert, but how do you avoid IRS Pub 525, p18, "Mortgage Relief upon Sale or Other Disposition?" For recourse loans it looks like income, for non-recourse loans it sounds like it would only matter once the forgiveness pushed your "gain" above the exemption threshold (personal residence).
Say one knows they're going to get foreclosed on in the near future, can't they just take a home equity loan (before they get foreclosed on) for the full equity they have in the house and cash the check and hide the money and that way they don't lose their equity in the house when they get foreclosed on?
I'm sure one could go to a loan shark, get the equity at 60% and put it in little hula girl dolls, ship them to the Amazon and catch a flight to Brazil, to hide in the rain forest for the rest of one's life. But why would one want to?
I know that in a "short sale" the seller is obligated to pay tax on the amount of debt forgiven. The difference between a regular foreclosure and a "short sa;e" is that you have to have bonafide offer from a buyer. You can read more here............. http://realtytimes.com/rtcpages/20031022_shortsale.htm If you qualify for the short sale, it isn't over until the tax collector sings. Any remaining difference between your home's value and the balance on your mortgage is considered a forgiveness of debt and, in virtually all cases, that's income that is taxable.
dont forget PMI. If you put down less than 20% on a home, most mortgage companies force you to pay for PMI, which insures the first 20% of a home's value. So if you buy at 100k, put down nothing, the market tanks and you walk away, the bank really only has 80k at risk. The first 20k is insured, courtesy of you cuz they make you pay for it. Its rolled into your monthly payment. Sweet deal huh? The bank gives you a loan and makes YOU pay for insuring their investment. That'd be like buying MSFT, and making Bill Gates pay for the 20% debit spread on the puts.