31.13 Foreclosure on Mortgages Other Than Purchase Money

If you, as a mortgagee (lender), bid in on a foreclosure sale to pay off a mortgage that is not a purchase money mortgage, your actual financial loss is the difference between the unpaid mortgage debt and the value of the property. For tax purposes, however, you may realize a capital gain or loss and a bad debt loss that are reportable in the year of the foreclosure sale.

Your bid is treated as consisting of two distinct transactions:

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image Planning Reminder
Voluntary Conveyance
Instead of forcing you to foreclose, the mortgagor may voluntarily convey the property to you in consideration for your cancelling the mortgage debt. Your loss is the amount by which the mortgage debt plus accrued interest exceeds the fair market value of the property. If, however, the fair market value exceeds the mortgage debt plus accrued interest, the difference is taxable gain. The gain or loss is reportable in the year you receive the property. Your basis in the property is its fair market value when you receive it.
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1. The repayment of your loan. To determine whether this results in a bad debt, the bid price is matched against the face amount of the mortgage.
2. A taxable exchange of your mortgage note for the foreclosed property, which may result in a capital gain or loss. This is determined by matching ...

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