For federal income tax purposes, if you borrow $1,000 and
later repay $800, the $200 difference is generally treated as ordinary debt
cancellation income. There are many exceptions, and one applies to principal
residence homeowners with debt cancellation income realized in 2007 through
2013. Like many provisions in the Tax Code, this was a temporary fix intended to
provide relief during the economic downturn, with a 2013 expiration date.
Without Congress acting on a so-called "extenders" package, there is no special
homeowner income tax relief for debt cancellation income in 2014.
What is the federal tax impact on troubled Arizona
single-family homeowners facing foreclosure in 2014? A path outlined in a recent
nonbinding IRS Information Letter (INFO
2014-0015, released June 27, 2014) may offer some hope.
After applying the protections afforded Arizona
single-family homeowners under the Arizona anti-deficiency statutes
— primarily, A.R.S. §§
— qualified purchase money
mortgages are made effectively nonrecourse. That is, if you borrow $1,000 to buy
your single-family residence, and the value later declines to $800, an Arizona
homeowner is not liable to the lender/creditor for the $200 deficiency.
Generally, if a debt is treated as nonrecourse, federal tax
law provides that a transfer of the collateral — i.e., the residence — in
satisfaction of the mortgage loan (whether voluntarily or through foreclosure)
is treated as "sale or exchange" gain under IRC Section 1001, reportable under
IRC Section 61(a)(3) and not ordinary debt cancellation income reportable under
IRC Section 61(a)(12). Thus, if an Arizona single-family residence was purchased
for $1,000, with a tax basis equal to $1,000, a foreclosure for the $1,000 debt
(assuming no payments made), would result in no gain or loss (or debt
cancellation income) being reported for federal income tax purposes.
Example. In 2010, an Arizona single-family personal
residence was purchased for $600,000, with all borrowed purchase money financing
and no down payment. In 2014, after the borrower had made no payments and the
property had declined in value, the bank forecloses on the secured single-family
residence. Assuming the residence qualifies under Arizona’s anti-deficiency
statutes, the taxpayer would report no gain or loss for federal income tax
purposes ($600,000 debt satisfied minus $600,000 tax basis).
My next Tax Alert discusses some recent cases addressing
the Arizona anti-deficiency statutes.
Article © Fred Witt 2014. All Rights Reserved.
Disclaimer: This alert is
provided for general information purposes and is not intended to constitute
legal or tax advice. Please consult with your own legal or tax advisor before making
any decisions concerning your financial or business matters.