4 Common Questions About Mortgage Foreclosure In Arizona
By Christopher M. McNichol and Kent E. Cammack, Attorneys, Gust Rosenfeld P.L.C. .
1. Is a Borrower Personally Liable After Foreclosure?
A borrower is generally personally liable to the lender for a loan including the shortfall, or "deficiency," created when the unpaid loan balance is more than the bid price/value of the property at a foreclosure auction. However, Arizona has statutory exceptions-commonly called the anti-deficiency statutes-that protect borrowers from liability in certain instances.
In particular, a borrower is not personally liable for a deficiency following foreclosure by a non-judicial trustee's sale if the property is: 1) 2½ acres or less and 2) limited to and utilized for either a single one- or two-family dwelling.
However, if the lender were to choose foreclosure by judicial action (a more involved process than a trustee's sale), there is a third element that must be met to qualify for anti-deficiency protection: 3) the loan must be "purchase money"-that is, the money borrowed was used to pay for all or part of that property. This means that borrowers are potentially on the hook for non-purchase money loans, including not only for a post-foreclosure deficiency but also if the lender elects to sue directly on the debt instead of foreclosing. This impacts home equity, home improvement and other "second" loans which were not used to purchase the property.
2. Does a "Short Sale" Wipe Out the Loan?
"Short sale" has come to mean a real estate sales transaction in which the lender agrees to release its secured lien against the property upon payment of less than what the borrower owes on the loan. Such a sale may make sense if the lender could not sell the property for a better price after foreclosure, because it could save all parties time and money and help avoid the stigma of a foreclosure against the property.
However, borrowers should never assume that a short sale alone will fully satisfy the loan obligation. As noted above, if the property doesn't qualify for anti-deficiency protection, the lender could pursue the borrower for the unpaid balance of the loan after the short sale. And there is also the issue of past-due homeowner's assessments, which are typically a personal obligation of the then-owner. This is why the borrower and lender should document the short sale arrangement, including addressing any continuing liability for the loan balance.
3. Are There Tax Consequences Resulting from a Foreclosure or Short Sale?
Cancellation of indebtedness (COI) income is phantom income realized by a taxpayer from a transaction where loan monies are forgiven. For example, if a borrower secured a $250,000 loan on a property and later that property is sold for $200,000 in a short sale or at a foreclosure auction, the borrower could have phantom income of $50,000-assuming the lender "forgave" this debt. This $50,000 is money that could count as "income" on the borrower's tax return.
The IRS takes the position, however, that there is no debt forgiveness on non-recourse debt. This means that if a borrower is protected by Arizona's anti-deficiency statutes, the loan is non-recourse debt and the borrower is not required to realize any COI income resulting from a short sale or foreclosure.
Conversely, if the property doesn't qualify for anti-deficiency protection, the loan debt would be recourse (i.e., the borrower is personally liable) and the borrower may have to pay taxes on the phantom income. If, however, the property is the borrower's primary residence, the borrower may be insulated from COI income realized from the short sale or foreclosure up to the IRS limits ($2 million for married couples and $1 million for single filers or married couples filing separately). It is important to consult a tax professional to determine if this exclusion could apply.
4. How are Residential Tenants Affected by Foreclosure?
In an effort to blunt how unsuspecting residential tenants are treated after a foreclosure, a federal law enacted in 2009 provides that for federally related loans a bona fide tenant is entitled to stay in the residence after foreclosure for the balance of the lease term at the specified rental rate. One key exception, however, is that a tenant's lease may be terminated with 90 days' notice if the property is sold to a purchaser who will occupy it as a primary residence.
Also, a new Arizona state law requires the landlord to give notice to any residential tenant if foreclosure action is pending against the leased property. If notice is not given, the tenant has certain rights against the landlord.
Complexities, qualifications, exceptions and nuances abound with all of these issues. Please consult with a qualified legal advisor to get the complete picture.
For More Information
For more information, please contact Chris McNichol and Kent Cammack using the contact information below.
Christopher M. McNichol - 602.257.7496 - firstname.lastname@example.org
Chris practices in the area of real estate and is co-author of Ins and Outs of Foreclosure.
Kent E. Cammack - 602.257.7459 - email@example.com
Kent practices in the area of real estate and is co-author of Ins and Outs of Foreclosure.