Tax issues with house foreclosures
Tax is a consideration in any financial arrangement and house foreclosures are no exception. As well as income tax considerations, you must also consider property taxes and other tax liens on the property you are buying.
The main reason most people invest in foreclosures is to make money. However, if you buy a property and then sell it on for a profit, you will make a significant capital gain, which is subject to government tax, just like your normal income. In fact, capital gains must be added to your normal income when you calculate your tax bracket.
The only way to avoid this is to use the property as your primary home for at least two years before you sell, which will entitle you to take home up to $250,000 (or $500,000 for a married couple) tax free. In addition, you will also pay income tax on any income you make from renting the property out.
Long-term capital gains are subject to slightly lower tax rates than standard income but a large capital gain may also have Alternative Minimum Tax (AMT) implications. This is a complicated business and its worth investing in an accountant who can help you take home as much as possible of your income.
Another important tax consideration is property tax. Most real estate is subject to property taxes and if these are not paid, the government can foreclose on the owner of the property, even if the arrears were due to the previous occupant.
You should investigate the tax liens an all foreclosure properties carefully before handing over any money. Otherwise, you could face foreclosure yourself because of a tiny amount of outstanding property tax owed by the previous owner.
You must also think about tax if you are a victim of foreclosure. If you opt for a pre-foreclosure sale, the capital gains will generally be small after you have paid off the outstanding debt. They should also be tax-free, subject to the usual limits for primary home sales.
However, if the lender agrees to waive some of the debt - which can happen as a result of foreclosure - the IRS will regard this amount as taxable income coming to you. This is another good reason to avoid foreclosure!