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“At least once every human should have to run for his life, to teach him that milk does not come from supermarkets, that safety does not come from policemen, that news is not something that happens to other people.”     Robert A. Heinlein,    The Number of the Beast

August 20, 2007

Lose Your House, Get Screwed By The I.R.S.

by Doug Mataconis

It’s bad enough to end up in an economic conundrum where you lose your house to foreclosure, but, wait, there’s something worse waiting for you from your friends fiends at the Internal Revenue Service:

Two years ago, William Stout lost his home in Allentown, Pa., to foreclosure when he could no longer make the payments on his $106,000 mortgage. Wells Fargo offered the two-bedroom house for sale on the courthouse steps. No bidders came forward. So Wells Fargo bought it for $1, county records show.

Despite the setback, Mr. Stout was relieved that his debt was wiped clean and he could make a new start. He married and moved in with his wife, Denise.

But on July 9, they received a bill from the Internal Revenue Service for $34,603 in back taxes. The letter explained that the debt canceled by Wells Fargo upon foreclosure was subject to income taxes, as well as penalties and late fees. The couple had a month to challenge the charges.

For those who struggle to pay their bills, who watch their housing payments rise out of reach with their adjustable-rate mortgages, who lose a job or who fall victim to illness, losing one’s home can feel like hitting bottom. But one more financial indignity may await as the fallout from the great housing boom ripples across the United States.

“Getting that tax bill,” Mrs. Stout recalled, “my first thought was that I needed to see my family doctor to help me with my stress, because we had a big mortgage and other debt and then here came the I.R.S. saying we owe this.”

In other words, we’re here from Uncle Sam to tell you that even though you’ve lost your house, and you’re probably unemployed, we’re still gonna suck you dry based upon a definition of “income” that even the drafters of the 16th Amendment would’ve thought ridiculous.


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4 Comments

  1. It isn’t just mortgages covered by this crap. Get a credit card company to forgive your debt and you can get hit as well. Somehow the IRS assumes that it isn’t that you couldn’t pay; rather, you were given a gift by the credit card company in order to pay them back your debt and a gift is taxable. For an organization that is so anal retentive about substance over form, they sure can come up with some of the oddest arguments. Then again, it is only odd if you believe the government doesn’t own the rights to your entire life, existence, what have you.

    Comment by trumpetbob15 — August 20, 2007 @ 10:05 pm
  2. Doug,

    You know I hate the taxes, but…if someone is deriving benefit from an economic transaction, even if that benefit is a negative one (such as debt forgiveness) it is completely logical for the IRS to treat that as revenue. I work in a job where I have to deal with promissory notes between family members and between employees/employers. The notes themselves vary on terms but they still have a limit of when they must be paid back (5 years usually) and if the notes enter default they must be declared as income to the IRS. Not doing so would create a huge loophole to get around paying income taxes for estates and wages, respectively. I’m all for abolishing the IRS and income tax, but as long as the government’s got the system in place they need to treat such transactions as taxable income…same as they should treat employer-provided health care as taxable income. Otherwise the system becomes a sham. Not that I’d be opposed to that happening. But that wasn’t really the point of your post…you were complaining that people who pay taxes on foreclosure are being treated unfairly under the system and they’re not. They’re being held to the same standards as most everyone else under the tax system.

    By the way, anyone who buys a house on an adjustable mortgage rate is an absolute sucker.

    Comment by UCrawford — August 20, 2007 @ 11:05 pm
  3. I checked on this with my tax-specialist wife and she explained that it’s perfectly reasonable for the IRS to dun the taxpayer. Here’s a contrived scenario that makes it clear:

    Mr. and Mrs. Smith own their house free and clear. It’s worth $250K, so they take out a $200K mortgage on it and use the $200K to buy stocks. Then the housing market takes a dive and their house is worth only $150K. They decide, quite rationally, that the house isn’t worth the mortgage, so they walk away from the house. The bank forecloses. The courthouse steps auction is legally required to start at the value of the mortgage, but nobody will pay $200K for a $150K house, so the bank gets the house and cancels the mortgage. So now Mr. and Mrs. Smith have $200K that they never paid any taxes on. Is that fair? Of course not!

    Now, any real-life situation is never this simple, and my wife has dealt with such situations, and she files an appeal and the IRS negotiates a reasonable deal. The usual problem is that Mr. and Mrs. Smith have already blown the money on vacations and cars and don’t have anything to pay the IRS.

    Comment by Chepe Noyon — August 21, 2007 @ 9:51 am
  4. Doug,

    Your article also notes that Wells Fargo (who bought the house) after they were notified of the situation filed a corrected 1099 form to indicate that the sale was not debt forgiveness because the house was eventually re-sold for more than the debt owed by the Stouts (thus the debt was paid). The IRS didn’t screw anybody here…they simply acted according to the documentation they had on file for the transaction, just like they’re supposed to do.

    The Stouts will have to pay legal bills to sort it all out, of course, but I’d also argue that they brought this problem on themselves by a) purchasing a house based on terms that were above their means, and b) not insuring that their paperwork, especially tax paperwork, was in order. They’re not getting any more of a raw deal than any other taxpayer who doesn’t keep their affairs in order.

    Comment by UCrawford — August 21, 2007 @ 10:51 am

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