December 15, 2020

For rental properties that have been foreclosed on, the IRS will view it as a sale. It is required to report any gain or loss you incur on your tax return. If the foreclosure increases the complexity of the transaction for tax reporting purposes, other factors must be considered such as who would be responsible for any remaining mortgage debt after the bank takes possession of the rental house.

How to calculate the tax basis on a rental house

The tax basis represents the total cost of the home in order to calculate your taxable gain or loss. It will also include the price that was paid for the rental house in addition to the cost of the permanent improvements that are made to it.

Calculating the amount on the foreclosure

In a typical sales transaction, the amount a taxpayer can realize is also known as the sales price. In a foreclosure, the amount will depend on if you are considered responsible for paying the mortgage debt or not. Should you be held responsible for the remaining mortgage balance, then the amount that you realize is equal to the fair market value of the house when it’s foreclosed on.

If the bank chooses to cancel any debt that is left on the mortgage, meaning you will no longer be liable for paying any of the debt back, then any amount in excess of the fair market value of the house is part of the ordinary taxable income. The ordinary income is considered separate from the gain or loss that is calculated on the foreclosure of a home.

Calculating the gain or loss

Once the realize amount is determined on the foreclosure, a taxpayer will need to subtract their tax basis from the amount to arrive at a gain or loss. If you’ve owned a rental house for more than a year, all losses will be considered ordinary. This means that it is fully deductible form the other income you report on a personal tax return.

Reporting the transactions to the IRS

It is required to report any foreclosures as well as the resulting gain or loss to the IRS by filling out Form 4797. If the foreclosure results in a long-term capital gain, then this amount will also need to be included on a Schedule D attachment with your return.

If a loss has incurred, then Form 4797 will be sufficient. Any cancelled debt that is taxable as ordinary income will also need to be reported on Form 1040.

Optima Tax Relief provides assistance to individuals struggling with unmanageable IRS tax burdens. To assess your tax situation and determine if you qualify for tax relief, contact us for a free consultation.