Who Pays the Taxes When a Property Is Foreclosed On?

When a property is foreclosed on, the original homeowner owes the property taxes right up until the foreclosure sale transfers title, and the new owner takes over from that point forward. Any unpaid property taxes that built up during the foreclosure get paid off the top from the auction proceeds, ahead of the mortgage and almost every other claim. The tax story doesn’t always end there, though: the IRS can treat forgiven mortgage debt as taxable income to the former owner, and the main exclusion that used to shield homeowners from that hit expired at the start of 2026.

Property Taxes During the Foreclosure Process

Filing foreclosure papers does not change who owns the home. Until the sale closes and title actually transfers, you are still the legal owner, and property tax bills keep accruing in your name. Depending on the state, that period can run from a few months to more than a year.

Most borrowers pay property taxes through an escrow account bundled into the monthly mortgage payment. Once mortgage payments stop, the lender stops forwarding escrow to the county, but the county still expects to be paid. Penalties and interest on the overdue balance vary by jurisdiction and commonly run between 6% and 23% annually. The longer foreclosure drags on, the bigger the unpaid tax bill grows, and that bill follows 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 very top. Under both state and federal law, a local government’s claim for unpaid property taxes outranks nearly every other lien on the property, including the mortgage. Federal law explicitly subordinates a federal tax lien to a local property tax lien where state law gives property taxes priority over prior security interests.¹

In practice, the county takes what it’s owed first. If a home sells for $200,000 with a $5,000 unpaid tax bill and a $180,000 mortgage balance, the county gets its $5,000, the lender gets the next $180,000, junior lienholders come after that, and anything left belongs to the former homeowner. Surplus proceeds don’t disappear. If the sale price exceeds all outstanding debts, you have a right to claim the difference, though the process and deadlines to do so vary by state.

Who Owes Property Taxes After the Foreclosure Sale

Once title transfers, the new owner picks up the property tax obligation going forward. That new owner is usually one of two parties.

If a third-party investor wins the auction, that buyer takes on the tax bill immediately. If no outside bidder offers enough to cover the debt, the lender typically makes a “credit bid” and takes ownership itself. The property then becomes what the industry calls Real Estate Owned, or REO, and the lender is responsible for property taxes, insurance, and upkeep until it resells.

Income Tax on Forgiven Mortgage Debt

Property taxes aren’t the only tax issue foreclosure creates for the former owner. The IRS treats a foreclosure as a sale of the 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.² Which tax applies depends on whether the loan is recourse or nonrecourse.

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, gain or loss is figured by comparing the property’s fair market value to your adjusted basis, and any portion of the debt the lender cancels beyond the fair market value is treated as ordinary cancellation-of-debt income. Say you owe $250,000, the home sells at foreclosure for $200,000, and the lender forgives the remaining $50,000. That $50,000 is taxable income unless an exclusion applies. The lender reports the forgiven amount on Form 1099-C.³

With a nonrecourse loan, the lender’s only remedy is to take the property. There is no cancellation-of-debt income, but the IRS treats the full outstanding loan balance as your “amount realized,” so you could still owe capital gains tax if that figure exceeds your basis.⁴⁵

Exclusions That Can Wipe Out the Tax

Several exclusions can shield you from owing tax on forgiven 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 amount of your insolvency. Many homeowners facing foreclosure qualify.⁶
Bankruptcy. Debts discharged in bankruptcy are not taxable income.⁵
Qualified principal residence indebtedness. This exclusion let homeowners 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 as of this writing.⁶

With the principal residence exclusion gone for new foreclosures, insolvency 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 exclude up to the amount of insolvency.⁶ Report the canceled debt on your return either way. The exclusion means you don’t owe tax on it, not that you skip the paperwork.²

Federal Tax Liens and the 120-Day IRS Redemption Right

If you owed back federal income taxes and the IRS had recorded a lien against the property, the foreclosure does not automatically wipe that lien out. Local property tax liens still outrank a federal tax lien, so the IRS gets paid only after the county and, generally, after any earlier-recorded mortgage.¹

The IRS also has a separate power that catches buyers off guard: a 120-day right of redemption. If the foreclosure sale satisfies a lien that is senior to the federal tax lien, the IRS can step in within 120 days (or longer if state law allows a longer redemption period) and reimburse the auction purchaser to take the property.⁷ The IRS then resells to recover both the reimbursement and its lien amount.⁸ The IRS rarely uses this power, but the possibility puts a cloud on the title for 120 days that affects resale and refinancing.

Real Estate Transfer Taxes

Some states impose a real estate transfer tax whenever property changes hands, and around 15 to 16 states plus the District of Columbia apply it to foreclosure deeds. The rest either exempt foreclosures or have no transfer tax. Where it applies, the tax is a percentage of the sale price or consideration.

Which party is technically liable depends on state and local custom. In many places the seller owes it, which in a foreclosure means the former homeowner, but the tax is usually paid from auction proceeds before distribution to lienholders. Either way, it reduces the net proceeds available to pay off liens and, potentially, to return surplus funds to you.

A Tax Sale Is Not the Same as a Mortgage Foreclosure

A mortgage foreclosure is the lender’s remedy for unpaid loan payments. A tax sale is the local government’s remedy for unpaid property taxes. The two are separate legal actions started by different parties, and a homeowner who is current on their mortgage can still lose their home to a tax sale if they fall behind on property taxes. Because the tax authority’s lien has super-priority, a tax sale can wipe out an existing mortgage, which is why most mortgage agreements require borrowers to keep property taxes current.

1
Office of the Law Revision Counsel. 26 USC 6323 – Validity and Priority Against Certain Persons
2
Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments
3
Internal Revenue Service. Instructions for Forms 1099-A and 1099-C
4
Internal Revenue Service. Recourse vs. Nonrecourse Debt
5
Internal Revenue Service. Home Foreclosure and Debt Cancellation
6
Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness
7
Office of the Law Revision Counsel. 26 USC 7425 – Discharge of Liens
8
Office of the Law Revision Counsel. 28 USC 2410 – Actions Affecting Property on Which United States Has Lien