At Schern Richardson Finter Decker , our practice focuses primarily on real estate and commercial litigation matters. However, as a result of the downturn in the Arizona real estate market, real estate practitioners in Arizona increasingly find themselves assisting clients with issues related to taxation and bankruptcy.
It has come to my attention that tax professionals are presently counseling their clients not to rush to complete the short sale on their principal residence prior to the impending expiration of the Mortgage Forgiveness Debt Relief Act of 2007 (the "Act"). The reason being that purchase money mortgages in Arizona are non-recourse debts because Arizona's anti-deficiency statutes preclude the lender from pursuing the borrower for a deficiency.
The problem with this argument is that the typical Deed of trust in Arizona, even on a purchase money loan, does not limit the lenders ability to pursue the borrower for a deficiency. In other words, lenders generally preserve their right to pursue the borrower for a deficiency. However, Arizona's anti-deficiency statutes render those recourse provisions ineffective.
Whether Arizona's anti-deficiency statutes render as "non-recourse" a loan agreement that contains recourse language is an unresolved issue. There is not a great deal of tax law that governs the definition of a non-recourse loan, nor has the IRS provided much guidance. IRS Publication 4681 (2010), Canceled Debts, Foreclosures, Repossessions, and Abandonments simply provides that: "Debt for which you are personally liable is recourse debt. All other debt is nonrecourse debt."
Those that have taken the position that purchase money mortgages in Arizona are non-recourse loans under the tax code may ultimately prove to be correct. However, without any clear guidance from the IRS, it's certainly a risky proposition at this point. As a firm, we counsel our clients to avoid risk and uncertainty whenever possible. Therefore, until this issue is resolved, we will continue to advise clients to endeavor to complete their short sale transactions prior to the expiration of the Act. Further, although they are not the subject of this article, there are also provisions under the tax code pertaining to bankruptcy, insolvency and investment properties that may also assist borrowers in avoiding harsh consequences that can result following debt forgiveness on a purchase money loan.