Fred Witt PLC, Phoenix Federal Tax Attorney

Tax Alert — September 2014

Impact of Mortgage Forgiveness Debt Relief Expiration on Arizona Homeowners

A path outlined in a recent IRS Information Letter may offer some hope for homeowners facing taxation of cancelled debt.

Fred Witt


Fred Witt


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. §§ 33-729(A) and 33-814(G) — 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.