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Yes, the house is in foreclosure and will go up for Auction in November.

The auction sale price is irrelevant. What is relevant is the FMV of the property on the date the bank legally takes back the property.

If they're still living in the property, I doubt that the bank has yet taken the property. But that's a state law thing, and I know nothing about Ohio foreclosures.

It's also important to know if the loan is a recourse loan (meaning that after foreclosure the bank can continue to go after her for any shortfall that wasn't satisfied by the bank selling the property) or a non-recourse loan (where the bank's only remedy is to take back the property and they CAN'T pursue the borrower for any shortfall).

If it's a non-recourse loan, there is no cancellation of debt income and there should be no 1099C. However there will be a 1099A, showing the amount of the loan that was satisfied by the foreclosure. Your friend would treat the foreclosure as a sale of the property with the sale price being the amount of the loan.

If it's a recourse loan, she'll treat the property as sold for the FMV of the property. If the FMV is less than the loan amount, that difference is Cancellation of Debt income and is potentially taxable. That's where IRC section 108 comes in.

If she meets one of the exceptions in sec 108, the cancellation of debt income will not be taxable. The most likely exception she'll meet is the one for homeowners that Phil has mentioned earlier. She might also be insolvent, which is a different exception. And if she files bankruptcy before the house is foreclosed (and I'm really not sure if the house has been foreclosed yet or not), she would qualify for the BK exception.

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