The Tax Consequences of Debt Forgiveness after Foreclosure and Short Sale.

The Tax Consequences of Debt Forgiveness after Foreclosure and Short Sale

The IRS states that there is no debt forgiveness on non-recourse debt/loans. In Arizona, non-recourse debts are mortgages that were used to purchase and/or improve homes, also known in most cases as, “purchase money loans.” An example of non-recourse debt/loan is a first mortgage which purchased 100% of a home. Another example of a non-recourse debt/loan is both a first and a second mortgage where the first mortgage went towards a percentage of the home purchase, and the second mortgage went towards another percentage of the home purchase. Here, because the second mortgage went towards purchasing the home, it is a non-recourse debt/loan. An example of what a non-recourse debt is not, is a second mortgage where the homeowner took out cash and used it for something else (e.g. buying a car, boat, etc.). Most of these loans are know as “home equity lines of credit” or “HELOCs”.

The Mortgage Debt Relief Act of 2007, provides for no tax on short sale difference or foreclosure deficiency of non-recourse loans, if the home is a primary residence. So, for example, if the homeowner had a simple 80/20 mortgage where both went 100% towards purchasing the home, the homeowner will not be taxed after short sale or foreclosure. If, however, the homeowner had a “HELOC”, or some other non-recourse loan which was forgiven, they will be issued form 1099 and taxed for the forgiveness.

Debt forgiveness on “HELOCs” and other non-recourse debts are rare after foreclosure and short sale on most occasions. Almost always, after short sale/foreclosure, the homeowner must make arrangements with their lender to pay the HELOC (unless of course in the foreclosure sale, the HELOC is satisfied or paid off entirely). If the homeowner does not make arrangements, they face collection and/or civil action.

After foreclosures or short sales which involve “HELOCs” many homeowners consider options available to them under the bankruptcy code. Filing for bankruptcy protection after foreclosure/short sale can discharge a homeowner’s obligations to pay a HELOC. Many homeowners who “see the writing on the wall” are considering their options even before foreclosure/short sale, when they know they will be unable to pay the HELOC afterwards. Filing for bankruptcy protection even before foreclosure or short sale can work retroactively in protecting homeowners from their obligations under a HELOC. It is important to seek the advice of an experienced bankruptcy attorney to know your rights and obligations.

Bankruptcy vs Debt Settlement

The benefits of filing bankruptcy vs debt settlement in Arizona
by Bankruptcy Attorney Mesa AZ

One of the benefits of debt settlement is the ability to satisfy your debt in full at a lower cost than what you owe. Some creditors may agree to settle your entire debt for single payment or in a payment plan at 50 to 75 cents on the dollar. Paying less than the balance owed is good for individuals with large sums of cash, however it offers no relief to others who lack the necessary cash or savings.

Bankruptcy chapters 7 and 13 can provide relief from a sudden financial problem caused by unemployment, underemployment, a reduction in income, or even a medical emergency. Individuals and families whose monthly expenses have grown beyond their income should consider filing for Chapter 7 bankruptcy in Arizona. This is a way to reduce overall liabilities by discharging all unsecured debt (i.e. credit cards, medical debt, personal loans) and allows individuals to pay only the essential obligations, such as a mortgage or auto loan.

Perhaps another benefit of debt settlement is that all fees associated with this service are paid out as a percentage on the money saved in settlement. Even though it appears as if settlement fees come off the amount saved, in reality these fees may be avoided all together when communicating directly with the creditors. Conversely, filing for bankruptcy in Arizona and the rest of the country, requires sufficient expertise in the field of bankruptcy in order to file the various forms required by bankruptcy court. Furthermore, most Mesa bankruptcy attorneys charge a one-time fee that is not affected by the amount of the debt discharged. As a result, filing for bankruptcy is easier to plan for.

One of the most important differences between debt settlement and bankruptcy is that unlike debt settlement, bankruptcy has no tax consequences. In a debt settlement, the amount that is forgiven is realized as taxable income, and you will issued a 1099 for it.

It’s always recommended to seek the advice of Arizona Bankruptcy Lawyer, before moving forward.