Two tax issues popped up as I discussed impending foreclosures with a client with several investment properties. Remember that a foreclosure sale is treated for tax purposes as though it was an actual sale, with the winning bid treated as though the property owner got the money. The result is that a capital gain may result. This is more likely if the property has been held for a substantial period and the tax basis reduced by depreciation or the property has been refinanced and the equity pulled out.
The second possible tax gotcha may arise in short sale situations where the amount of the shortage may result in cancellation of debt income.