Does AZ forgive taxes on foreclosures like the Fed?

[FacingNorth]

Regarding the Federal law that forgave taxes on foreclosed and modified properties until 2009 (extended to 2013); I read that CA also extended this for state taxes, but only for 2007/2008.

Does anyone know what the deal is in AZ?

[cactus77727]

Hi Facing North,

I'm a Arizona homeowner too. (not a tax professional) I was wondering the same thing. I was thinking that because in AZ we use the Federal adjusted gross income as a starting point for our AZ 140 form that the forgiveness occurs on the federal return, and thus translates to the AZ return. I haven't gotten a definitive answer yet but I found this so far:

Debt Forgiveness as Income. Notwithstanding the issue of anti-deficiency protection, the loss of a residence is not necessarily the ultimate consequence of a foreclosure, as cancellation of debt can trigger a crushing tax liability.

If a lender cancels a debt, the lender is obligated to send to the borrower and the IRS a “Form 1099-C: Cancellation of Debt” for the year in which the debt is cancelled. The resulting cancellation of debt may be taxable as ordinary income to the taxpayer.

Fortunately, Arizona’s anti-deficiency statutes, the Internal Revenue Code and the Mortgage Forgiveness Debt Relief of Act of 2007 offer various exceptions for taxpayers who have received a 1099-C.

One exception pertains to “non-recourse” debt, in which the loan documents specifically state that, in the event of a deficiency, the lender would have no recourse against the borrower. In Arizona, many residential loan documents have recourse provisions (i.e., they theoretically preserve the lender’s right to pursue the borrower for a deficiency). However, the state’s anti-deficiency statutes render those recourse provisions ineffective. Whether the statutes render as “non-recourse” a loan agreement that contains recourse language is another unresolved issue, and the borrower’s tax liability may depend on the IRS’s interpretation.

(Other exceptions to the taxability of cancelled debt include bankruptcy and insolvency on the part of the borrower at the time the loan was cancelled.)
The Mortgage Forgiveness Debt Relief of Act of 2007 remedies some of these issues. The Act applies to transactions after January 1, 2007, and before January 1, 2010, and permanently excludes debt forgiveness from income if (a) the real property was the principal residence of the taxpayer; (b) the debt was for the purchase, construction or substantial improvement of the foreclosed property; and (c) the foreclosed property was the taxpayer’s primary residence for two of the past five years.

Conversely, the Act’s protections do not apply if (a) the property did not qualify as the borrower’s principal residence or (b) in refinancing the first mortgage, the borrower used part of the loan proceeds for purposes unrelated to the property (e.g., an auto purchase, payment of college tuition, consumer debt repayment, etc.) The last provision again raises the challenge of distinguishing the purchase money portion from the non-purchase money portion.

One last tax consideration in a foreclosure is whether the residence had been used for a business purpose, such a rental or for a home office, and there has been depreciation claimed in past years. The foreclosure could cause a capital gain because of the past depreciation.

[FacingNorth]

Hey cactus77727,

That's a great point about AZ taxes using the Fed return as it's base. Thanks for posting the info that you found. I'm unsure how to decipher this part; it seems contradictory to me:

Originally Posted by cactus77727

In Arizona, many residential loan documents have recourse provisions (i.e., they theoretically preserve the lender’s right to pursue the borrower for a deficiency). However, the state’s anti-deficiency statutes render those recourse provisions ineffective. Whether the statutes render as “non-recourse” a loan agreement that contains recourse language is another unresolved issue, and the borrower’s tax liability may depend on the IRS’s interpretation.

[cactus77727]

Most of it seems contradictory to me too!

What I think that means is: laywers and legislators, have made so many laws, and rewritten them so many times, over and over, again and again, that they don't even know what they mean anymore. So folks, you'll just have to hire an attorney to figure it all out on a case by case basis.

Sorry to be sarcastic, but I'm thinking: what a scam!

[cactus77727]

Seriously, I think (at least in in my case) everything is trumped by ARS 33-814 - G

G. If trust property of two and one-half acres or less which is limited to and utilized for either a single one-family or a single two-family dwelling is sold pursuant to the trustee's power of sale, no action may be maintained to recover any difference between the amount obtained by sale and the amount of the indebtedness and any interest, costs and expenses.

I was concerned on my Notes, because there is recourse language in mine. But it ends with "unless prohibited by law" and G. above is the law. Thank goodness!