There was a settlement as part of a foreclosure counterclaim. The multi-year foreclosure itself was stopped via an internal trial modification that led to a permanent modification, but at that point the principal balance was much higher than the original principal because they added missed payments, taxes, insurance, etc.

According to the counterclaim, the bank orchestrated the foreclosure and forced acceptance of the modification (complete with the higher principal) in order to keep the house. Thus, the compromised settlement damages were based on the increased principal balance and the attorney fees involved.

So the question is: Would the settlement be non-taxable, taxable as income, an adjustment to cost basis, or something else entirely? If it makes a difference, the property started as a primary residence, but has been acting as a rental property for the last few years, complete with depreciation deductions.

Thanks!

So the question is: Would the settlement be non-taxable, taxable as income, an adjustment to cost basis, or something else entirely?========>> I guess it depends;The most important of these is the exclusion for debt secured by your main home. Under the Mortgage Forgiveness Debt Relief Act, canceled debts of up to $2 million can be excluded as long as the debt was used to buy or build your principal residence. This tax exclusion technically expired at the end of 2016, but it still covers debts that are forgiven in 2017 if a written agreement was entered into in 2016. And Congress reopened the issue in January 2017, so it's possible that the Act will ultimately be extended into future years
In general, the IRS is concerned, a foreclosure is the same as the sale of a property. The bottom line is that it once was yours and now it's not. This means the event MAY trigger a capital gain / loss, and if any part of the mortgage debt is forgiven / cancelled, income tax may be due on that amount as well. The basic formula for calculating capital gains is to subtract the adjuted basis /adj. cost of the property from the sales price. The difference is how much profit yu made, or how much money was lost on the transaction. In a foreclosure situation and without escrow statements, the selling price used for tax purposes isn't immediately clear. There's no mutually agreed upon sales price. The "sales price" for tax purposes will be either the fair market value of the property or the outstanding loan balance immediately prior to the foreclosure, depending on the type of loan you had. Both these figures will be reported to you and to the IRS by the lending institution on Form 1099-A.Also, your mortgage was either a recourse /a non-recourse loan. Mortgages used to acquire your house tend to be non-recourse loans, while refinanced loans and home equity loans tend to be recourse loans. This is by no means an absolute rule, however. It can also depend on the state in which you reside.So aslongas you had a recourse loan, you're personally liable for the debt and the lender can pursue you for repayment even after the property has been repossessed. In this case, the figure used as the sales price when calculating your capital gain or loss is the lesser of the following ;The outstanding loan balance immediately before the foreclosure minus any debt for which the borrower remains personally liable after the foreclosure or the fair market value of the property being foreclosed.

So, foreclosures can trigger taxable income besides capital gains. If your lender forgives/ cancels the mortgage debt on a recourse loan, you might have to include this as income, but there are a few exceptions that can exclude canceled debts from tax treatment. Form 1099-A is issued by the bank after real estate has been foreclosed. It reports the the date of the foreclosure, the fair market value of the property, and the outstanding loan balance immediately prior to the foreclosure. You'll need this information when you're reporting any capital gain income related to the foreclosure.
Form 1099-C is issued by the bank after the bank has canceled / forgiven any debt on a recourse loan. This form will indicate how much debt was canceled. If a lender both forecloses on a home and cancels the unpaid debt in the same year, you may receive only a single Form 1099-C that reports both the foreclosure and the cancellation of debt instead of receiving both a 1099-A and a 1099-C. After you've determined what type of loan you had on your property, you can determine the sales price.If the foreclosed property was your primary residence, report the foreclosure on Sch D and Form 8949. You may qualify to exclude up to $500K($250K as single filer) of gain from income tax subject to certain rules: the home was your primary residence; you lived in it for at least two of the last five. Some additional rules apply. If the foreclosed property was mixed-use?it was your primary residence at one time and a secondary residence as a rental home pr etc at another time, then, you may still qualify for an exclusion from capital gains tax under the modified rules for calculating your gain or loss.As of 2017, the tax rate on long-term capital gains for properties, those owned a year or longer, is 15% for taxpayers who fall in the 25 through 35 % tax brackets.If the foreclosed property was a rental property, you need to report the sale on Form 4797.

Thank you for your comprehensive reply. However, I must apologize, because I think I did a poor job explaining the situation.

The property was never sold or foreclosed upon. It was in foreclosure for several years, but ultimately, the foreclosure was stopped by agreeing to an in-house modification. No principal was forgiven. In fact, the principal increased dramatically, because the bank added missed payments and everything escrow would have covered over those years.

So, the house was ~not~ foreclosed/sold and the new loan (modification) is say $100K MORE than the original loan, and payments are being made to that new loan.

At the same time, a settlement against the counterclaims was reached. Basically, the counterclaim says the bank orchestrated a foreclosure that ultimately ended in having to accept an in-house modification with a much higher principal balance. Thus, the damages were based on that $100K increase in principal balance of the modified loan (plus legal fees).

So, the settlement is really an offset for the greater sum-of-payments that will be made through the upcoming years to keep the house.

Thank you for your comprehensive reply. However, I must apologize, because I think I did a poor job explaining the situation.

The property was never sold or foreclosed upon. It was in foreclosure for several years, but ultimately, the foreclosure was stopped by agreeing to an in-house modification. No principal was forgiven. In fact, the principal increased dramatically, because the bank added missed payments and everything escrow would have covered over those years.

So, the house was ~not~ foreclosed/sold and the new loan (modification) is say $100K MORE than the original loan, and payments are being made to that new loan.

At the same time, a settlement against the counterclaims was reached. Basically, the counterclaim says the bank orchestrated a foreclosure that ultimately ended in having to accept an in-house modification with a much higher principal balance. Thus, the damages were based on that $100K increase in principal balance of the modified loan (plus legal fees).

So, the settlement is really an offset for the greater sum-of-payments that will be made through the upcoming years to keep the house.

Thank you for your comprehensive reply. However, I must apologize, because I think I did a poor job explaining the situation.

The property was never sold or foreclosed upon. It was in foreclosure for several years, but ultimately, the foreclosure was stopped by agreeing to an in-house modification. No principal was forgiven. In fact, the principal increased dramatically, because the bank added missed payments and everything escrow would have covered over those years.

So, the house was ~not~ foreclosed/sold and the new loan (modification) is say $100K MORE than the original loan, and payments are being made to that new loan.

At the same time, a settlement against the counterclaims was reached. Basically, the counterclaim says the bank orchestrated a foreclosure that ultimately ended in having to accept an in-house modification with a much higher principal balance. Thus, the damages were based on that $100K increase in principal balance of the modified loan (plus legal fees).

So, the settlement is really an offset for the greater sum-of-payments that will be made through the upcoming years to keep the house.

[[My reply isn't showing up, so I'm trying to post again; I apologize if multiple copies show up]]

Thank you for your comprehensive reply. However, I must apologize, because I think I did a poor job explaining the situation.

The property was never sold or foreclosed upon. It was in foreclosure for several years, but ultimately, the foreclosure was stopped by agreeing to an in-house modification. No principal was forgiven. In fact, the principal increased dramatically, because the bank added missed payments and everything escrow would have covered over those years.

So, the house was ~not~ foreclosed/sold and the new loan (modification) is say $100K MORE than the original loan, and payments are being made to that new loan.

At the same time, a settlement against the counterclaims was reached. Basically, the counterclaim says the bank orchestrated a foreclosure that ultimately ended in having to accept an in-house modification with a much higher principal balance. Thus, the damages were based on that $100K increase in principal balance of the modified loan (plus legal fees).

So, the settlement is really an offset for the greater sum-of-payments that will be made through the upcoming years to keep the house.

Thank you for your comprehensive reply. However, I must apologize, because I think I did a poor job explaining the situation.

The property was never sold or foreclosed upon. It was in foreclosure for several years, but ultimately, the foreclosure was stopped by agreeing to an in-house modification. No principal was forgiven. In fact, the principal increased dramatically, because the bank added missed payments and everything escrow would have covered over those years.

So, the house was ~not~ foreclosed/sold and the new loan (modification) is say $100K MORE than the original loan, and payments are being made to that new loan.

At the same time, a settlement against the counterclaims was reached. Basically, the counterclaim says the bank orchestrated a foreclosure that ultimately ended in having to accept an in-house modification with a much higher principal balance. Thus, the damages were based on that $100K increase in principal balance of the modified loan (plus legal fees).

So, the settlement is really an offset for the greater sum-of-payments that will be made through the upcoming years to keep the house.

Oh, man. Sorry for all the duplicates. My reply wasn't showing up, even after waiting some time, so I thought there was a problem with my submission. So, I reposted again...and again...and again ...and then with other browsers. SORRY!