Arizona Short Sale Liability - Deficiency and Debt Forgiveness

Short Sale Liability - Deficiency and Debt Forgiveness

A primary residence that sits on less than 2 1/2 acres - According to AZ Anti Deficiency Law Section G, No action may be taken by a lender to recover any shortage between the sale amount and what's owed.

Arizona Anti Deficiency Law:

Section G of this law provides the most insight to the statutes covering the majority of homeowners.

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G. If trust property of two and one-half acres or less which is limited to and utilized for either a single one-family or a single two-family dwelling is sold pursuant to the trustee's power of sale, no action may be maintained to recover any difference between the amount obtained by sale and the amount of the indebtedness and any interest, costs and expenses.

Full version of the Arizona Anti-Deficiency Law

The Mortgage Forgiveness Debt Relief Act and Debt Cancellation

Cancellation of Debt
If you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes, depending on the circumstances. When you borrowed the money you were not required to include the loan proceeds in income because you had an obligation to repay the lender. When that obligation is subsequently forgiven, the amount you received as loan proceeds is normally reportable as income because you no longer have an obligation to repay the lender. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt.

Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which generally is taxable income to you.

Is Cancellation of Debt income always taxable?
Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:

Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.
Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.

These exceptions are discussed in detail in Publication 4681.
Full version of the Debt Forgiveness Act Publication 4681

Disclaimer to this information: Green Street Realty is not acting as a Real Estate attorney or CPA / tax expert by providing this information. If you are facing default and foreclosure proceedings have started, you should consult with an experienced real estate attorney and CPA, specific to the state in which your property is located. They can review your specific situation and advise you of your liability and protection under the anti-deficiency and tax liability laws of your specific state.