Deeds In Lieu of Foreclosure
Homeowners may end the foreclosure process by paying off the debt before the foreclosure sale begins. This is known as an equity of redemption, not to be confused with a right of redemption following a sale. Texas recognizes the right of redemption following tax sales only. No right of redemption follows a mortgage foreclosure sale. In all probability, though, homeowners who have defaulted on their monthly payments would lack the financial ability to retire the entire debt before the sale. A second option is to refinance the debt with another lender, although poor credit records or the time needed to complete the transaction may make this alternative impossible.
The homeowner’s third option is to sell the property and pay off the debt. Again, timing is critical. The homeowner should list and sell the property before the home is posted for foreclosure. Potential buyers may avoid making an offer thinking they can get a better price by bidding at the foreclosure sale.
Finally, homeowners may attempt to convey the property back to the lender in exchange for cancelling the debt. This is known as a deed in lieu of foreclosure (DILF), and it requires the lender’s consent and cooperation.
The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for this relief. Debt forgiveness in lieu of foreclosure appears to fall under these provisions. The act applies to debt forgiven in calendar years 2007 through 2010. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion doesn't apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home's value or the taxpayer's financial condition