It is a common misconception that a borrower‘s financial obligations end when a piece of property is foreclosed upon by the lender. Unfortunately, this is not true-- receiving a notice of default is just the beginning of a process that should have the full attention of the borrower as well as the lender.

Taxes after foreclosure can accrue when a lender is forced to resell a property for below fair market value and loses money on the deal. In today‘s market this is the rule, not the exception, with many banks being force to settle for significantly less than the amount of money they originally lent out. In some cases, a bank will ask the courts for a deficiency judgment, which would allow them to recover the difference from the borrower through a payment plan or potentially even docking their pay.

But these days, so many mortgages are defaulting and banks are so pessimistic about recovering this money in the future that they are usually willing to settle with the defaulting borrower and cancel at least some of the remaining debt (if not all of it.) The Internal Revenue Service considers this arrangement to result in something called cancellation of debt income, or COD. And, as with pretty much any other kind of income, Uncle Sam expects to receive his cut.

Your tax liability after foreclosure does not end there. Did you fail to pay your property taxes in full while you still owned the home? Are their liens on your property? If so, the bank will subtract these liens from whatever they sell your property for, further increasing your COD and the tax on foreclosure.

Sometimes a borrower who has been foreclosed upon has no idea that they owe the federal government this money (which often hits tens of thousands of dollars.) Unless you know that the debt exists and make an attempt to resolve it with the IRS, it can wreak havoc on your credit rating for years to come — which is the last thing somebody who has just lost their house needs.