Real Estate Attorney Christopher Combs sends out weekly email articles regarding various topics related to real estate. I find his recent article below timely, as many homeowners who are contemplating a short sale or possible foreclosure, are concerned about tax liability on forgiven debt. Especially as the Mortgage Debt Relief Act is set to expire on 12/31/2012.
Tax Liability for Debt Forgiveness in Arizona
If there is a short sale or foreclosure of a home the mortgage lender will generally send a Form 1099 to the borrower for the amount of the mortgage debt forgiveness. Prior to the Mortgage Debt Relief Act, this amount was generally taxable income to the borrower. Stevens v. C.I.R., 2008 WL 2264452 (T.C. 2008) (Illinois couple paid income tax on $74,000 of debt forgiveness after 2003 short sale of their home).
If the Mortgage Debt Relief Act, as discussed in a recent email, is not extended beyond December 31, 2012, borrowers in most states will have to pay income tax on the amount of mortgage debt forgiveness.
Under the anti-deficiency statutes in Arizona, however, a mortgage loan to purchase a home is a non-recourse loan, i.e., no personal liability of the borrower. The Internal Revenue Service has consistently ruled that debt forgiveness of a non-recourse loan is not taxable income. See I.R.S. Publication 4681. This publication states that “if you are not personally liable for the debt, you do not have ordinary income from the cancellation of the debt…” Therefore, in Arizona, if the Mortgage Debt Relief Act is not extended beyond December 31, 2012, there may be no tax liability for any debt forgiveness in a short sale or foreclosure.