Payments made to servicemembers and co-borrowers for foreclosure violations of Sections 521 and 533 of the Servicemembers Civil Relief Act (“SCRA”) – pursuant to Exhibit H of the NMS Consent Order – will be reported to the IRS. The tax consequences for these payments may differ from that of other NMS payments because the harm being compensated is different and because some SCRA victims are being compensated for properties other than their principal residence. Note that just because a payment is reported to the IRS does not mean that it is taxable. Your tax treatment will depend on your particular facts and circumstances. The Department of Justice, independent consultants, settlement administrators, and servicers are not able to provide tax advice. Please contact a professional tax advisor or other qualified financial counselor with any questions concerning taxes.
The following information is based on general guidance from the IRS regarding compensation for SCRA foreclosure violations. This information will also be provided on the check stubs attached to the payments. Note that these payments may include one or more of the following components: a lump sum payment, lost equity, and interest on lost equity.
Lump Sum Portion of Settlement Payment. Generally, you must include the lump sum payment in gross income. In limited circumstances, however, you may be able to exclude part or all of the lump sum payment from gross income. For example, you may qualify to exclude part or all of the payment from gross income if you can show that the servicer made the payment to reimburse specific nondeductible expenses (such as living expenses) that you incurred because of the SCRA violation. It is likely that you must include most or all of the lump sum payment in your income.
Lost Equity Portion of Settlement Payment. If you lost your main home in foreclosure, you should treat the lost equity payment as an additional amount you received on the foreclosure of the home. You will have a gain on the foreclosure only if the sum of the lost equity payment and the value of the main home at foreclosure is more than what you paid for the home. In many cases, this gain may be excluded from income. More information on the rules for excluding all or part of any gain from the sale (including a foreclosure) of a main home are on pages 10 through 15 of Publication 523, Selling Your Home, which is available on the IRS website, www.irs.gov.
Example 1: John paid $100,000 to buy his main home. The house was valued at $85,000 at the time of foreclosure. In 2015, John received a lost equity payment of $10,000. The sum of the home’s value at foreclosure and the lost equity payment is $95,000 ($85,000 + $10,000), which is less than the $100,000 John paid for the home. Therefore, John does not have a gain on the foreclosure of the home and does not include the $10,000 lost equity payment in income.
Example 2: The facts are the same as in Example 1 except that John received a lost equity payment of $20,000. The sum of the home’s value at foreclosure and the lost equity payment is $105,000 ($85,000 + $20,000), which is $5,000 more than the $100,000 John paid for the home. Thus, John has a gain of $5,000 on the foreclosure of the home. John generally can exclude the $5,000 from income if he qualifies under rules that allow exclusion from income of all or part of any gain from the sale of a main home. Otherwise, John must include the $5,000 in income.
The rules that apply to a lost equity payment you received for the foreclosure of a property that was not your main home are different. The rules for reporting gain or loss on the foreclosure of property that was not your main home are in Publication 544, Sales and Other Dispositions of Assets, which also is available on the IRS website, www.irs.gov.
Interest Payment on Lost Equity Portion of Settlement Payment. You must include any interest on the lost equity portion of your settlement payment in your income.