Question: I read an article you wrote in 2010 about foreclosures and short sales. I work on a foreclosure defense project and I was wondering what will happen now that the Mortgage Debt Relief Act of has expired. Will borrowers have any other relief from mortgage debt forgiveness counting as taxable income in 2017?
Answer: Yes. The Mortgage Debt Relief Act of 2007 (the “Act”) prevented mortgage forgiveness on a qualified principal residence resulting from a short sale or foreclosure from counting as taxable income against the borrower. Originally set to expire after 2009, the Act was extended several times with the last extension expiring on January 1, 2017. It is still possible that new legislation could be passed later this year extending the Act and applying it retroactively but no such legislation is pending. Additionally, foreclosures nationwide continue to decline and are back to June 2007 levels, with Arizona’s foreclosures even below the national average (only .3% of homes with a mortgage).
However, there is good news for homeowners and also investors in Arizona who are contemplating foreclosure. There is still potential relief from taxable income on debt forgiveness following a foreclosure even without the Act. While all debt forgiveness is generally taxable income, there is usually an exemption for what is referred to as “non-recourse” debt. A non-recourse debt is a debt where the lender’s recourse is limited to the collateral given for the debt, e.g., the home pledged as security for repayment of a mortgage. In other words, the lender cannot collect payment from the borrower personally or any of the borrower’s other assets.
Why is this important? In many states it is not, but in Arizona, nearly all loans used to purchase a home are non-recourse debts under Arizona law. Even many loans that were not used to purchase a home are usually still non-recourse debts in Arizona where they are secured by a home. And unlike the Act, which only applied to principal residence, Arizona’s statutes regarding non-recourse mortgages apply to all qualifying homes, even vacation homes and homes used as investment rentals (no spec homes, unfinished homes, and vacant lots).
Finally, rules regarding bankruptcy and insolvency may provide additional exemptions from taxable income for debt forgiveness. Each situation is different, but relief should be available.