Watching their house get taken by the bank may seem like hitting rock bottom for some taxpayers. However, they may be surprised to find a decent tax liability from their foreclosure as well. If a taxpayer doesn’t claim income from getting out of their mortgage debt, they can wind up facing a notice of unpaid taxes, which will probably be more common as so many people across the country are falling behind on their mortgage payments.

Foreclosure is the main way that taxpaying homeowners can fall into this tax liability. The other is when homeowners are forced to sell their homes for less than the value of the mortgage. If the lender forgives that difference, they the taxpayers will be held liable for income on the difference.

The Center for Responsible Lending claims that 20 percent of the loans made in 2005 and 2006 to people with poor credit, often using subprime loans, will likely end in foreclosure. Typically these types of loans require very little as a down payment, so without any equity many of these houses are being valued at much less then is owed on them.

Some people finding themselves in this predicament are fighting the tax liabilities and getting them reduced. In certain cases, taxes can be negotiated with the Internal Revenue Service and settled for less then the full amount. Then in some cases, bankruptcy or a claim of insolvency can eliminate the tax burden.

"The tax laws are far too complex for borrowers to understand," claim Kurt Eggert, a professor at Chapman University Law School. "There are distinctions between selling a house for less than the loan amount and losing the house in foreclosure. It is crucial to get expert tax advice to sort through the bewildering complications."

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