If you, as a mortgagee (lender), bid in on a foreclosure sale to pay off a mortgage that is not a purchase money mortgage, your actual financial loss is the difference between the unpaid mortgage debt and the value of the property. For tax purposes, however, you may realize a capital gain or loss and a bad debt loss that are reportable in the year of the foreclosure sale.
Your bid is treated as consisting of two distinct transactions:
Where the bid price equals the mortgage debt plus unreported but accrued interest, you report the interest as income. But where the accrued interest has been reported, the unpaid amount is added to the collection expenses.
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