Was the house Foreclosed by the lender? The IRS views the foreclosure of a property as a sale. The gain or loss is calculated on the difference between:
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Adjusted basis (cost) of the property. (Purchase price plus improvements less accumulated depreciation)
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Sale Price.of the property. For foreclosure, the sale price depends on whether you are responsible for the remaining mortgage debt or not. If you aren’t, then the house sale price is equal to the remaining mortgage balance that exists when the bank forecloses. But if you are responsible for paying the remaining balanceof the mortgage, then the amount you realize is equal to the fair market value of the house when it’s foreclosed on.
Additionally, if the bank cancels your debt, meaning you no longer need to pay it back, then any amount of debt cancelled which is in excess of the fair market value of the house, is part of your ordinary taxable income. This ordinary income is separate from the gain or loss you calculate on the foreclosure of the home. The bank should have sent you a form 1099-C. I have included additional information. The Article on Foreclosure below, also contains additional links to other articles.
Publ 544 Article
on foreclosure
