Forgiven Debt

• An individual has forgiven foreclosure debt when his foreclosure resulted in a deficiency that his lender chose not to pursue. Lenders opt not to pursue borrowers for foreclosure debt for a variety of reasons. For example, a lender may forgive a borrower's debt if the cost of pursuing the debt via a lawsuit exceeds the debt itself. In this case, it makes more financial sense for the lender to forgive the balance.
  
  

Required Forgiveness

• In an effort to protect borrowers who have already suffered the loss of their homes, some states enforce "non-recourse" laws for mortgage lenders. In a non-recourse state, a lender may foreclose on an individual's home, but the lender must accept the property as payment in full for the loan balance. Even if a deficiency is present after the foreclosure sale, the lender can neither file a lawsuit against the borrower nor report the forgiven amount to the Internal Revenue Service (IRS) as a business loss.
  
  

Considerations

• A lender has several years during which it can legally file suit against a former borrower for a deficiency balance, depending on the statute of limitations for such lawsuits in the borrower's state of residence. Because of this, a lender can wait years before pursuing the consumer for the deficiency. If the individual is not aware of the foreclosure deficiency or the lender's right to wait before collecting it, a lawsuit may take him by surprise. Even if an individual is aware of the outstanding balance, as time passes, he may assume the bank forgave his foreclosure debt only to discover that it did not. According to CNN Money, banks sometimes wait for borrowers to recover financially after foreclosure before filing suit. This increases the bank's chances of recovering the debt.
  
  

Tax Liability

• Just because a mortgage lender forgives a borrower's foreclosure debt does not mean the IRS will. Mortgage lenders notify individuals of the full forgiven amount via a Form 1099 that each consumer must file with her tax return. Unless the individual qualifies for tax forgiveness under the Mortgage Forgiveness Debt Relief Act (MFDRA), she must pay taxes on the forgiven balance.
  
  Individuals who qualify for tax forgiveness under the MFDRA are those who lost their primary homes to foreclosure and whose lenders forgave less than $1 million -- or $2 million if the home was owned by a couple filing a joint return. If an individual qualifies for tax forgiveness, she must file Form 982 with her tax return noting she is legally exempt from paying taxes on her forgiven foreclosure debt.