From the IHT:
Two years ago, William Stout lost his home in Allentown, Pennsylvania, 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, 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 U.S. Internal Revenue Service for $34,603 in back taxes. The letter explained that the amount of 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.
The Stouts had originally tried to sell the house themselves and thought the bank takeover extinguished the debt.
“Getting that tax bill, 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 IRS saying we owe this,” Denise Stout recalled.
For those who struggle to pay their bills, who watch their housing payments rise out of reach with their adjustable 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.
Notices of unpaid taxes, unanticipated and little understood, will probably multiply as more people fall behind on their mortgages, explained Ellen Harnick, senior policy counsel at the Center for Responsible Lending, a nonpartisan research and policy center in Durham, North Carolina.
Foreclosure is one way that beleaguered homeowners can fall into this tax trap. The other is when homeowners are forced to sell their homes for less than the value of the mortgage. If the lender forgives that difference, they are liable for income taxes on that amount.
The “1099 shortfall,” as it is called, stems from an Internal Revenue Service policy that treats forgiven debt as income even if the taxpayer has nothing tangible to show for it.