The Internal Revenue Service doesn't let many transactions slide under the radar. If you own real property and the lender forecloses -- or if you otherwise transfer your interest in the property back to the lender such as with a deed in lieu of foreclosure -- any capital gain or loss you realize must be reported on your tax return. The IRS considers the transaction a sale. Unfortunately, you can't deduct a loss.
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Information on Form 1099-A
After a foreclosure or deed in lieu, your lender should send you a 1099-A form -- "Acquisition or Abandonment of Secured Property." The form includes two important numbers: the principal balance of your mortgage at the time of the foreclosure or deed in lieu in box 2 and your property's fair market value in box 4. Box 5 tells you whether you had a recourse or nonrecourse loan, which determines how you'll make calculations.
How to Report
If you had a nonrecourse loan, the amount of money you owed at the time of the foreclosure or transfer of the property is the "sales price." If you had a recourse loan, the sales price is your loan's outstanding principal balance or the property's fair market value, whichever is less. Determine your adjusted basis in the property, which is what you originally paid for it plus the costs of any capital improvements, then subtract that number from your sales price. Report the resulting number as a gain or loss on Schedule D and line 13 of your Form 1040 return.