So, the election is over and the "fiscal cliff" is awaiting. Will The Mortgage Forgiveness Debt Relief Act of 2007 (the "Act") be extended? Given its bi-partisan support in the past, I would venture to say that it likely will be extended another year.
The extension of the Act is a concern for many given that the housing market is nowhere near out of the woods. The real issue is that if the Act is not extended, borrowers in most states will have to pay income tax on the amount of any debt forgiven in a short sale, deed in lieu of foreclosure, or foreclosure.
However, for some property owners in Arizona, the expiration of the Act may not have any appreciable impact because of Arizona’s broad anti-deficiency protections for borrowers. Assuming your property is located on under 2 1/2 acres and utilized as a single or two-family home, the property is deemed a qualifying property for anti-deficiency protection. Additionally, assuming your loan (and even a second loan) was used for the purchase of the home, it is deemed a non-recourse loan and and any deficiency will not be considered income because it is non-recourse debt. See I.R.S. Publication 4681. This IRS Publication states that "if you are not personally liable for the debt, you do not have ordinary income from the cancellation of the debt…" Therefore, in Arizona, even if the Act is not extended, you may not have any tax liability in the event of a short sale or foreclosure if your property is protected by Arizona’s anti-deficiency statutes.