When a home is foreclosed, the former owner owes property taxes up to the moment title transfers at the sale, and whoever takes title — a third-party auction buyer or the lender itself — owes them from that point forward. The bigger surprise for many people is the second tax bill foreclosure can trigger: the IRS may treat forgiven mortgage debt as taxable income, and the main exclusion that used to shield homeowners from that income expired on January 1, 2026.
Property Taxes Before the Foreclosure Sale
Until the foreclosure sale is final and title actually transfers, you are still the legal owner. Property taxes keep accruing in your name, even if you stopped paying the mortgage months earlier and the lender has already filed foreclosure papers. Depending on the state, the foreclosure process can take anywhere from a few months to more than a year, and the tax bills for that entire stretch belong to you.
Most borrowers pay property taxes through an escrow account bundled into the monthly mortgage payment. Once you stop paying the mortgage, the lender stops forwarding escrow funds to the county, but the county still expects payment. Penalties and interest start stacking up. Rates vary by jurisdiction, but they commonly run between 6% and 23% annually on the overdue balance. The longer the foreclosure drags on, the larger the unpaid tax bill grows, and that bill travels with the property to the auction.
How Unpaid Property Taxes Get Paid at the Auction
Foreclosure sale proceeds are distributed by lien priority, and property tax liens sit at the top of that hierarchy. Under state and federal law, a local government’s claim for unpaid property taxes outranks virtually every other lien on the property, including the mortgage. Federal law explicitly makes even a federal tax lien subordinate to a local property tax lien where state law gives property taxes priority over prior security interests.1Office of the Law Revision Counsel. 26 USC 6323 – Validity and Priority Against Certain Persons
In practice, the county is paid first from the auction proceeds, before the mortgage lender receives anything. If a home sells for $200,000 with a $5,000 unpaid tax bill and a $180,000 mortgage balance, the county takes its $5,000 off the top, the lender receives the next $180,000, and any remaining funds go to junior lienholders. Whatever is left after that belongs to the former homeowner. Surplus proceeds don’t vanish. If the sale price exceeds all outstanding debts, you have a right to claim the difference, though the process and deadlines vary by state.
Who Owes Property Taxes After the Sale
Once the sale closes and title transfers, the new owner picks up the property tax obligation going forward. That new owner is usually one of two parties: a third-party bidder who bought the property at auction, or the foreclosing lender itself.
When no outside bidder offers enough to cover the outstanding debt, the lender typically makes a credit bid and takes ownership. The property then becomes Real Estate Owned, or REO. As the new owner, the lender is responsible for property taxes, insurance, and basic upkeep until it resells. Lenders generally try to move REO properties quickly because every month of ownership adds carrying costs. If a third-party investor wins the auction, that buyer assumes the tax obligation immediately upon taking title.
Income Tax on Forgiven Mortgage Debt
Property taxes aren’t the only tax issue foreclosure creates. The IRS treats a foreclosure as a sale of property, which means you may owe capital gains tax on any increase in value and you may owe ordinary income tax on any mortgage debt the lender forgives.2Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments How this works depends on whether your loan is recourse or nonrecourse.
Recourse Loans
Most mortgages are recourse loans, meaning the lender can pursue you personally for any shortfall between the sale price and what you owe. With a recourse loan, foreclosure produces two separate tax events. First, gain or loss is calculated by comparing the property’s fair market value at the time of foreclosure to your adjusted cost basis. Second, any portion of the debt the lender cancels beyond the fair market value is treated as ordinary cancellation-of-debt income.2Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments
Suppose you owe $250,000 on a home that sells at foreclosure for $200,000, and the lender forgives the remaining $50,000. The IRS treats that $50,000 as taxable income unless an exclusion applies. The lender reports the forgiven amount on Form 1099-C.3Internal Revenue Service. Instructions for Forms 1099-A and 1099-C
Nonrecourse Loans
With a nonrecourse loan, the lender’s only remedy is to take the property; they can’t pursue you for the difference. The IRS treats the full outstanding loan balance as your amount realized in the sale, even if the property was worth less than what you owed.4Internal Revenue Service. Recourse vs. Nonrecourse Debt There is no cancellation-of-debt income on a nonrecourse loan, but you could still owe capital gains tax if the deemed sale price exceeds your cost basis.5Internal Revenue Service. Home Foreclosure and Debt Cancellation
Exclusions That Can Wipe Out the Tax on Forgiven Debt
Several exclusions can shield you from owing tax on canceled mortgage debt.
- Insolvency. If your total debts exceeded the fair market value of all your assets immediately before the debt was canceled, you can exclude the canceled amount up to the extent of your insolvency. Many homeowners going through foreclosure qualify, since the foreclosure itself suggests debts outweigh assets.6Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness
- Bankruptcy. Debts discharged in bankruptcy are not taxable income.5Internal Revenue Service. Home Foreclosure and Debt Cancellation
- Qualified principal residence indebtedness. The QPRI exclusion allowed homeowners to exclude up to $750,000 ($375,000 if married filing separately) of forgiven mortgage debt on a primary residence. It expired on January 1, 2026. It still applies if your debt was forgiven under a written agreement entered into before that date, even if the actual discharge happened later. Legislation to make the exclusion permanent has been introduced in Congress but not enacted.6Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness
With QPRI gone for new foreclosures, the insolvency exclusion is the most broadly available protection. Calculate your total assets and liabilities as of the day before the debt was canceled. If liabilities exceeded assets by at least the amount of forgiven debt, the entire amount is excludable. If the gap is smaller, you can still exclude up to the amount of insolvency.6Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness Either way, you must still report the canceled debt on your return; the exclusion means you don’t owe tax on it, not that you skip the paperwork.2Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments
Transfer Taxes and the IRS Redemption Right
Two side items are worth knowing about because they can cut into what would otherwise be your surplus or complicate the buyer’s title.
Some states impose a real estate transfer tax whenever property changes hands, including through foreclosure. Around 15 to 16 states plus the District of Columbia apply their transfer tax to foreclosure deeds; the rest either exempt foreclosures or don’t have a transfer tax at all. Where it applies, it’s a percentage of the sale price. Which party pays depends on state and local custom. The seller is often technically liable, which in a foreclosure means the former homeowner, but the tax is usually paid from the auction proceeds before distribution to lienholders. That reduces the funds available to pay off liens and the surplus that might come back to you.
If the former owner had an IRS lien on the property, the federal tax lien is subordinate to the local property tax lien and, depending on filing dates, may be paid or wiped out by the sale.1Office of the Law Revision Counsel. 26 USC 6323 – Validity and Priority Against Certain Persons Even where the lien is wiped, the IRS keeps a 120-day right of redemption (longer if state law provides a longer redemption period) to reimburse the auction buyer and take the property.7Office of the Law Revision Counsel. 26 USC 7425 – Discharge of Liens The IRS then resells to recover the reimbursement and its lien.8Office of the Law Revision Counsel. 28 USC 2410 – Actions Affecting Property on Which United States Has Lien The IRS rarely exercises this right, but the 120-day cloud on title can affect resale or refinancing for auction buyers.
One boundary worth flagging: a tax sale is not the same thing as a mortgage foreclosure. If the local government forecloses because property taxes went unpaid, that is a separate proceeding by a separate party, and it can happen even to a homeowner who is current on the mortgage. The tax lien’s super-priority means a tax sale can wipe out an existing mortgage, which is why most mortgage agreements require borrowers to keep property taxes current.