Today's mortgage market is a difficult one and many people are facing foreclosures after failing to make payments on time. Many people don't realize that a bank foreclosure isn't necessarily the end of your housing troubles - the IRS may soon contact you regarding taxes you owe in connection with the property you no longer own!

Tax problems associated with foreclosures surface when the lender forgives some of your loan. The amount that is forgiven is usually considered cancellation of debt or discharge of debt. Unfortunately, this is considered COD income and is taxed at ordinary tax rates which can be as high as 35%. On top of that, foreclosures are treated as a normal sale. This means that if the sale of your house by the bank produces a gain in a nonrecourse mortgage, then it is a capital gain and you are responsible for the taxes.

So, while you may be able to get out of a large mortgage payment, you will still be paying taxes to the IRS. Granted these problems may not be giant for those who owe only $10k or $20k; however, if you have a $500,000 mortgage and the bank can only get $300,000 in a foreclosure sale, then you're talking about some real tax liability. The IRS rarely misses these types of transactions and will levy penalties and interest if they are not paid.